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

  • Maurice Obstfeld

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.

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File URL: http://www.nber.org/papers/w2539.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2539.

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Date of creation: Mar 1988
Date of revision:
Publication status: published as The European Monetary System, edited by Francesco Giavazzi, Stefano Micossi , and Marcus Miller. New York: Cambridge University Press, 1988.
Handle: RePEc:nbr:nberwo:2539
Note: ITI IFM
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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Web page: http://www.nber.org
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  1. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  2. Corden, W Max, 1986. "Exchange Rate Depreciation, the Current Account and Wages," The Economic Record, The Economic Society of Australia, vol. 0(0), pages 14-21, Supplemen.
  3. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
  4. Feenstra, Robert C, 1985. "Anticipated Devaluations, Currency Flight, and Direct Trade Controls in a Monetary Economy," American Economic Review, American Economic Association, vol. 75(3), pages 386-401, June.
  5. Flood, Robert P & Garber, Peter M, 1983. "A Model of Stochastic Process Switching," Econometrica, Econometric Society, vol. 51(3), pages 537-51, May.
  6. Guillermo A. Calvo, 1983. "Staggered Contracts and Exchange Rate Policy," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 235-258 National Bureau of Economic Research, Inc.
  7. Obstfeld, Maurice, 1984. "Balance-of-Payments Crises and Devaluation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 208-17, May.
  8. Kenneth S. Rogoff, 1984. "Can exchange rate predictability be achieved without monetary convergence? : evidence from the EMS," International Finance Discussion Papers 245, Board of Governors of the Federal Reserve System (U.S.).
  9. Giavazzi, Francesco & Pagano, Marco, 1986. "The Advantages of Tying One's Hands: EMS Discipline and Central Bank Credibility," CEPR Discussion Papers 135, C.E.P.R. Discussion Papers.
  10. Maurice Obstfeld & Alan C. Stockman, 1983. "Exchange-Rate Dynamics," NBER Working Papers 1230, National Bureau of Economic Research, Inc.
  11. Blanco, Herminio & Garber, Peter M, 1986. "Recurrent Devaluation and Speculative Attacks on the Mexican Peso," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 148-66, February.
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