A Center-Periphery Model of Monetary Coordination and Exchange Rate Crises
Willem H. Buiter
Citigroup; European Bank for Reconstruction and Development (EBRD) - Office of the Chief Economist; University of Cambridge - Trinity College; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS); University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)
Paolo A. Pesenti
Federal Reserve Bank of New York; National Bureau of Economic Research (NBER)
NBER Working Paper No. w5140
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.
Number of Pages in PDF File: 43working papers series
Date posted: July 5, 2000
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo1 in 0.641 seconds