Balance-of-Payments Crises and Devaluation

21 Pages Posted: 27 Apr 2000 Last revised: 9 Jul 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: April 1983

Abstract

The collapse of a fixed exchange rate is typically marked by a sudden balance-of-payments crisis in which"speculators" fleeing from the domestic currency acquire a large portion of the central bank's foreign exchange holdings.Faced with such an attack, the central bank often withdraws temporarily from the foreign exchange market, allowing the exchange rate to float freely before devaluing and returning to a fixed-rate regime. This paper links the timing of the initial speculative attack to the magnitude of the expected devaluation and to the length of the transitional period off loating. An implication of the analysis is that there exist devaluations so sharp and transition periods so short that acrisis must occur the moment the market first learns that the current exchange parity will eventually be altered. For sufficiently long transition periods, the floating exchange rate"overshoots" its new peg before appreciating back toward it;for shorter periods, the rate depreciates monotonically to its new fixed level. Accordingly, the central bank's return tothe foreign exchange market can occasion a capital outflow or a capital inflow.

Suggested Citation

Obstfeld, Maurice, Balance-of-Payments Crises and Devaluation (April 1983). NBER Working Paper No. w1103. Available at SSRN: https://ssrn.com/abstract=227119

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