A Center-Periphery Model of Monetary Coordination and Exchange Rate Crises

43 Pages Posted: 5 Jul 2000 Last revised: 27 Aug 2010

See all articles by Willem H. Buiter

Willem H. Buiter

Citigroup New York; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Columbia University

Giancarlo Corsetti

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)

Date Written: June 1995

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.

Suggested Citation

Buiter, Willem H. and Corsetti, Giancarlo and Pesenti, Paolo A., A Center-Periphery Model of Monetary Coordination and Exchange Rate Crises (June 1995). NBER Working Paper No. w5140. Available at SSRN: https://ssrn.com/abstract=225205

Willem H. Buiter (Contact Author)

Citigroup New York

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Giancarlo Corsetti

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

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Paolo A. Pesenti

Federal Reserve Bank of New York ( email )

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National Bureau of Economic Research (NBER)

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