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On the timing of balance of payments crises: Disaggregated information and interest rate policy

This paper proposes a dynamic framework to study the timing of balance of payments crises. The model incorporates two main ingredients: (i) investors have private information; (ii)investors interact in a dynamic setting, weighing the high returns on domestic assets against the incentives to pull out before the devaluation. The model shows that the presence of disaggregated information delays the onset of BOP crises, giving rise to discrete devaluations. It also shows that high interest rates can be e ective in delaying and possibly avoiding the abandonment of the peg. The optimal policy is to raise interest rates sharply as fundamentals become very weak. However, this policy is time inconsistent, suggesting a role for commitment devices such as currency boards or IMF pressure.

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File URL: http://www.econ.upf.edu/docs/papers/downloads/840.pdf
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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 840.

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Date of creation: Dec 1999
Date of revision: Feb 2002
Handle: RePEc:upf:upfgen:840
Contact details of provider: Web page: http://www.econ.upf.edu/

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  1. Stock, James H, 1987. "Measuring Business Cycle Time," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1240-61, December.
  2. Obstfeld, Maurice, 1984. "Balance-of-Payments Crises and Devaluation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 208-17, May.
  3. Martin D.D. Evans & Richard K. Lyons, 1999. "Order Flow and Exchange Rate Dynamics," NBER Working Papers 7317, National Bureau of Economic Research, Inc.
  4. Kraay, Aart, 2000. "Do high interest rates defend currencies during speculative attacks ?," Policy Research Working Paper Series 2267, The World Bank.
  5. Amartya Lahiri & Carlos A. Vegh, 2000. "Delaying the Inevitable: Optimal Interest Rate Policy and BOP Crises," NBER Working Papers 7734, National Bureau of Economic Research, Inc.
  6. Stock, James H., 1987. "Measuring Business Cycle Time," Scholarly Articles 3425950, Harvard University Department of Economics.
  7. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  8. Peter M. Garber, 1998. "Derivatives in International Capital Flows," NBER Working Papers 6623, National Bureau of Economic Research, Inc.
  9. Simon Johnson & Peter Boone & Alasdair Breach & Eric Friedman, 1999. "Corporate Governance in the Asian Financial Crisis," William Davidson Institute Working Papers Series 297, William Davidson Institute at the University of Michigan.
  10. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
  11. Christophe Chamley, 1999. "Coordinating Regime Switches," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 869-905, August.
  12. Flood, Robert P & Jeanne, Olivier, 2000. "An Interest Rate Defence of a Fixed Exchange Rate?," CEPR Discussion Papers 2507, C.E.P.R. Discussion Papers.
  13. Dornbusch, Rudiger, 1987. "Collapsing exchange rate regimes," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 71-83, October.
  14. 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.
  15. John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384, June.
  16. 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.
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