A Center-periphery Model of Monetary Coordination and Exchange Rate Crises, Issue 5140
National Bureau of Economic Research, 1995 - Currency question - 39 pages
Abstract: The paper analyzes the modalities and consequences of a breakdown of cooperation between the monetary authorities of inflation-prone Periphery Countries that use an exchange rate peg as an anti- inflationary device, when the Center is hit by an aggregate demand shock. Cooperation in the Periphery is constrained to be symmetric: costs and benefits must be equal for all. Our model suggests that there are at least two ways in which a generalized crisis of the exchange rate system may emerge. The first is when the constrained cooperative response of the Periphery is a moderate common devaluation while the non-cooperative equilibrium has large devaluations by a few countries. An exchange rate crisis emerges if Periphery countries give in to their individual incentives to renege on the cooperative agreement. In the second case, the Center shock is not large enough to trigger a general devaluation in the constrained cooperative equilibrium; yet some of the Periphery countries would devalue in the Nash equilibrium, making the monetary stance in the system more expansionary. In this case, reversion to Nash is collectively rational. We offer this model as a useful parable for interpreting the collapse of the EMR in 1992-93.
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Timing number and size of realignments in the Periphery
Symmetric cooperation in the Periphery
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abandoning the peg aggregate demand shock analysis bilateral real exchange Center country ceteris paribus cooperative agreement coordinated symmetric equilibrium cost of abandoning countries devalue country i's crises currency devaluation rate domestic Economic effective real exchange employment equation exchange rate crisis exchange rate parity exchange rate regime exchange rate system exchange rate target expansion in country expansionary expectations fixed exchange rate fixed parity floating exchange rate framework GDP deflator given fundamentals implies inflationary bias intra-Periphery loss function maintain the peg monetary expansion money demand money stock money supply money wage Nash equilibrium national horizontal equity NBER Working Papers nominal exchange rate nominal wages objective function Obstfeld optimal monetary policy output Periphery countries Periphery nations play Nash policy actions policy coordination policy makers reaction functions real exchange rate real interest rate realization Si,t speculative attack target level variables vis-à-vis the Center welfare cost