The Logic of Currency Crises

64 Pages Posted: 14 Jun 2000 Last revised: 14 Sep 2010

See all articles by Maurice Obstfeld

Maurice Obstfeld

University of California, Berkeley; Peterson Institute for International Economics; National Bureau of Economic Research; Centre for Economic Policy Research

Date Written: February 1994

Abstract

Once one recognizes that governments borrow international reserves and exercise other policy options to defend fixed exchange rates during currency crises, the question arises: What factors determine a government's decision to abandon a currency peg or hang on? In a setting of purposeful action by the authorities, the possibility of self-fulfilling crises becomes important. Speculative anticipations depend on conjectured government responses, which depend, in turn, on how price changes that are themselves fueled by expectations affect the government's economic and political positions. The circular dynamic implies a potential for crises that need not have occurred, but that do because market participants expect them to. In contrast to this picture, most previous literature on balance-of- payments crises ignores the response of government behavior to markets. That literature, I argue, throws little light on events such as the European Exchange Rate Mechanism collapse of 1992-93. This paper then presents two different models in which crisis and realignment result from the interaction of rational private economic actors and a government that pursues well-defined policy goals. In both, arbitrary expectational shifts can turn a fairly credible exchange-rate peg into a fragile one.

Suggested Citation

Obstfeld, Maurice, The Logic of Currency Crises (February 1994). NBER Working Paper No. w4640. Available at SSRN: https://ssrn.com/abstract=226945

Maurice Obstfeld (Contact Author)

University of California, Berkeley ( email )

530 Evans Hall #3880
Berkeley, CA 94720
United States

HOME PAGE: http://www.mauriceobstfeld.com

Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research ( email )

London
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
309
Abstract Views
4,215
rank
99,999
PlumX Metrics