When Are Fixed Exchange Rates Really Fixed? / Andres Velasco.

By:

Velasco, Andres

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w5842.Publication details: Cambridge, Mass. National Bureau of Economic Research 1996.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: This paper analyzes the sustainability of fixed exchange rates by extending the Barro-Gordon framework to a fully dynamic context in which the level of a state variable (in this case debt) determines the payoffs available to the government at each point in time. The model yields the following results. If debt is sufficiently low, there is an equilibrium in which the government does not devalue. For an intermediate range of debt levels, the government devalues in response to an attack but not otherwise, so that self-fulfilling attacks can occur. Finally, for yet another debt range there can also be sunspot equilibria in which an attack (and the corresponding devaluation) occurs with positive probability.

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Working Paper	Biblioteca Digital	Colección NBER	nber w5842 (Browse shelf(Opens below))	Not For Loan

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Previous	nber w5839 International Implications of German Unification /	nber w5840 The Adoption of Workers' Compensation in the United States 1900-1930 /	nber w5841 Volatility and the Investment Response /	nber w5842 When Are Fixed Exchange Rates Really Fixed? /	nber w5843 The Effects of Short-Term Variation in Abortion Funding on Pregnancy Outcomes /	nber w5844 Neoclassical vs. Endogenous Growth Analysis: An Overview /	nber w5845 Is There a Role for Monetary Aggregates in the Conduct of Monetary Policy? /	Next

November 1996.

This paper analyzes the sustainability of fixed exchange rates by extending the Barro-Gordon framework to a fully dynamic context in which the level of a state variable (in this case debt) determines the payoffs available to the government at each point in time. The model yields the following results. If debt is sufficiently low, there is an equilibrium in which the government does not devalue. For an intermediate range of debt levels, the government devalues in response to an attack but not otherwise, so that self-fulfilling attacks can occur. Finally, for yet another debt range there can also be sunspot equilibria in which an attack (and the corresponding devaluation) occurs with positive probability.