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 - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: March 1988

Abstract

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: https://ssrn.com/abstract=425566

Maurice Obstfeld (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-9646 (Phone)
510-642-6615 (Fax)

HOME PAGE: http://emlab.berkeley.edu/users/obstfeld/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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