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Explaining the Duration of Exchange-Rate Pegs

  • Michael W. Klein
  • Nancy P. Marion

This paper is a theoretical and empirical investigation into the duration of exchange-rate pegs. The theoretical model considers a policy-maker who must trade off the economic costs of real exchange- rate misalignment against the political cost of realignment. The optimal time to spend on a peg is derived and factors that influence peg duration are identified. The predictions of the model are tested using logit analysis with a data set of exchange-rate pegs for sixteen Latin American countries and Jamaica during the 1957-1991 period. We find that the real exchange rate is a significant determinant of the likelihood of a devaluation. Structural variables, such as the openness of the economy and its geographical trade concentration, also significantly affect the likelihood of a devaluation. Finally, political events that change the political cost of realignment, such as regular and irregular executive transfers, are empirically important determinants of the likelihood of a devaluation.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4651.

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Date of creation: Feb 1994
Date of revision:
Publication status: published as Journal of Development Economics, Vol. 54, no. 2 (December 1997): 387-404.
Handle: RePEc:nbr:nberwo:4651
Note: IFM
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  1. Gilbert E. Metcalf, 2006. "Value-Added Tax," Discussion Papers Series, Department of Economics, Tufts University 0608, Department of Economics, Tufts University.
  2. Heller, H Robert, 1978. "Determinants of Exchange Rate Practices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(3), pages 308-21, August.
  3. Rodrik, Dani, 1993. "Trade Liberalization in Disinflation," CEPR Discussion Papers 832, C.E.P.R. Discussion Papers.
  4. Samuel Kortum, 1994. "A Model of Research, Patenting, and Productivity Growth," Boston University - Institute for Economic Development 37, Boston University, Institute for Economic Development.
  5. Heckman, James J. & Singer, Burton, 1984. "Econometric duration analysis," Journal of Econometrics, Elsevier, vol. 24(1-2), pages 63-132.
  6. Goldberg, Linda S., 1994. "Predicting exchange rate crises : Mexico revisited," Journal of International Economics, Elsevier, vol. 36(3-4), pages 413-430, May.
  7. Wyplosz, Charles, 1986. "Capital controls and balance of payments crises," Journal of International Money and Finance, Elsevier, vol. 5(2), pages 167-179, June.
  8. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  9. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
  10. 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.
  11. Holden, Paul & Holden, Merle & Suss, Esther C, 1979. "The Determinants of Exchange Rate Flexibility: An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 61(3), pages 327-33, August.
  12. Robert Flood & Nancy Marion, 1994. "The Size and Timing of Devaluations in Capital-Controlled Developing Countries," NBER Working Papers 4957, National Bureau of Economic Research, Inc.
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