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A center-periphery model of monetary coordination and exchange rate crises

Buiter, Willem H., Corsetti, G. and Pesenti, P. (1995) A center-periphery model of monetary coordination and exchange rate crises. CEPDP, 246. Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

The paper analyzes the modalities and consequences of a breakdown of cooperation between the monetary authorities of inflation-prone Periphery Countries that use an exchange rate peg as an anti-inflationary device, when the Center is hit by an aggregate demand shock. Cooperation in the Periphery is constrained to be symmetric: costs and benefits must be equal for all. Our model suggests that there are at least two ways in which a generalized crisis of the exchange rate system may emerge. The first is when the constrained cooperative response of the Periphery is a moderate common devaluation while the non-cooperative equilibrium has large devaluations by a few countries. An exchange rate crisis emerges if Periphery countries give in to their individual incentives to renege on the cooperative agreement. In their second case, the Center shock is not large enough to trigger a general devaluation in the constrained cooperative equilibrium, making the monetary stance in the system more expansionary. In this case, reversion to Nash is collectively rational. We offer this model as a useful parable for interpreting the collapse of the ERM in 1992-3.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk
Additional Information: © 1995 The Authors
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Sets: Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 246
Date Deposited: 13 Aug 2008 12:52
URL: http://eprints.lse.ac.uk/20727/

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