Destabilizing Effects of Exchange-Rate Escape Clauses

39 Pages Posted: 18 Apr 2002 Last revised: 21 May 2002

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: January 1991

Abstract

This paper studies the merits of policy rules with escape clauses, analyzing as an example fixed exchange-rate systems that allow member countries the freedom to realign in periods of stress. Motivating this example is the debate within the European Monetary System over how quickly to move from the current regime of national currencies, linked by pegged but adjustable exchange rates, to a single European currency. The paper's main point is that while well-designed rules with escape clauses can raise society's welfare in principle, limited credibility makes it difficult for governments to implement such rules in practice. An EMS-type institution - which presumably imposes a political cost on policymakers who realign - may lead to an optimal escape-clause equilibrium, but may just as well lead to alternative equilibria far inferior to an irrevocably fixed exchange rate. Countries can suffer periods in which no realignment occurs, yet unemployment, real wages, and ex post real interest rates remain persistently and suboptimally high.

Suggested Citation

Obstfeld, Maurice, Destabilizing Effects of Exchange-Rate Escape Clauses (January 1991). NBER Working Paper No. w3603. Available at SSRN: https://ssrn.com/abstract=307865

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
28
Abstract Views
745
PlumX Metrics