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Competitiveness, Realignment, and Speculation: The Role of Financial Markets

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  • Maurice Obstfeld

Abstract

Current and planned measures liberalizing the external capital accounts of France and Italy call into question the continued viability of the policy of periodic exchange-rate realignment followed to date in the European Monetary System (EMS). This paper is intended as a first step in studying the real and monetary effects of EMS-style realignments in a setting of free cross-border financial flows. The first set of results derived concerns a situation in which there are no fundamental factors behind domestic inflation. Under a policy regime in which domestic inflation automatically triggers devaluation, the economy can undergo self-fulfilling depreciation-inflation spirals, triggered by speculative attack on the exchange rate. Such spirals do not occur when realignments do not offset past inflation fully. The second set of results shows how an exchange rate collapse can occur after inflation is set off by expansionary fiscal policy. Sometimes, but not always, the crisis will be preceded by a period of capital inflows and real currency appreciation. In other cases fiscal expansion may set off an immediate crisis.

Suggested Citation

  • Maurice Obstfeld, 1988. "Competitiveness, Realignment, and Speculation: The Role of Financial Markets," NBER Working Papers 2539, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2539
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    Cited by:

    1. Chris Kirrane, 2018. "Implications of EMU for the European Community," Papers 1805.12113, arXiv.org.
    2. Miller, Marcus & Weller, Paul, 1988. "Exchange Rate Bands And Realignments In A Stationary Stochastic Setting," Economic Research Papers 268344, University of Warwick - Department of Economics.
    3. Garcia Rocabado, Daniel, 2010. "The road to monetary union in Latin America: An EMS-type fixed exchange rate system as an intermediate step," W.E.P. - Würzburg Economic Papers 85, University of Würzburg, Department of Economics.
    4. Jean Pisani-Ferry & Claude Bismut, 1993. "L'union économique et monétaire : principes et implications," Revue Économique, Programme National Persée, vol. 44(1), pages 121-142.
    5. Eric Dehay & Pascal Michelena, 1994. "S. M. E. et policy-mix dans la perspective del'U.E.M," Revue Française d'Économie, Programme National Persée, vol. 9(3), pages 113-156.
    6. Pierre Villa, 1997. "Ces taux de change réels qui bifurquent," Working Papers 1997-05, CEPII research center.
    7. Kirrane, Chris, 1994. "Implications of EMU for the European Community," MPRA Paper 88998, University Library of Munich, Germany.

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