Competitiveness, Realignment, and Speculation: the Role of Financial Markets

29 Pages Posted: 7 Apr 2004

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: March 1988


Current and planned measures liberalizing the external capital accounts of France and Italy call into question the continued viability of the policy of periodic exchange-rate realignment followed to date in the European Monetary System (EMS). This paper is intended as a first step in studying the real and monetary effects of EMS-style realignments in a setting of free cross-border financial flows. The first set of results derived concerns a situation in which there are no fundamental factors behind domestic inflation. Under a policy regime in which domestic inflation automatically triggers devaluation, the economy can undergo self-fulfilling depreciation-inflation spirals, triggered by speculative attack on the exchange rate. Such spirals do not occur when realignments do not offset past inflation fully. The second set of results shows how an exchange rate collapse can occur after inflation is set off by expansionary fiscal policy. Sometimes, but not always, the crisis will be preceded by a period of capital inflows and real currency appreciation. In other cases fiscal expansion may set off an immediate crisis.

Suggested Citation

Obstfeld, Maurice, Competitiveness, Realignment, and Speculation: the Role of Financial Markets (March 1988). NBER Working Paper No. w2539. Available at SSRN:

Maurice Obstfeld (Contact Author)

University of California, Berkeley ( email )

530 Evans Hall #3880
Berkeley, CA 94720
United States


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 )

United Kingdom

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