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Shocks and the Viability of a Fixed Exchange Rate Commitment

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  • Torben Andersen

Abstract

The incentive to renege on a commitment to a fixed exchange rate is shown to be state contingent. A fixed exchange rate policy is not viable under “unusual” circumstances, and the incentive to violate the commitment is larger in the case of contractionary shocks than in the case of expansionary shocks. The possibility that the exchange rate regime is changed in “unusual” circumstances has significant effects also under “normal” circumstances, implying systematic devaluation expectations, excessive real wages and (ex post) real rates of interest, lower output and loss of reserves, which in turn reduces the incentive to initiate a fixed exchange rate policy. Moreover, policyshifts may be contagious among countries. Copyright Kluwer Academic Publishers 1998

Suggested Citation

  • Torben Andersen, 1998. "Shocks and the Viability of a Fixed Exchange Rate Commitment," Open Economies Review, Springer, vol. 9(2), pages 139-156, April.
    • Handle: RePEc:kap:openec:v:9:y:1998:i:2:p:139-156
    DOI: 10.1023/A:1008212301510
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    References listed on IDEAS

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    Cited by:

    1. Frank Bohn, 2006. "Greed, Impatience and Exchange Rate Determination," Working Papers 200605, School of Economics, University College Dublin.
    2. Pierre-Guillaume Méon & Jean-Marc Rizzo, 2002. "The Viability of Fixed Exchange Rate Commitments: Does Politics Matter? A Theoretical and Empirical Investigation," Open Economies Review, Springer, vol. 13(2), pages 111-132, April.
    3. Rasmussen, Bo Sandemann, 2002. "Credibility, cost of reneging and the choice of fixed exchange rate regime," Economics Letters, Elsevier, vol. 76(3), pages 419-427, August.
    4. Inchauspe, Julian, 2008. "Modeling currency instability: The 1997 Asian crisis re-examined," MPRA Paper 93050, University Library of Munich, Germany.
    5. Lai, Ching-chong & Chang, Juin-jen & Chang, Wen-ya, 2001. "Currency devaluation in an open-shop union," International Review of Economics & Finance, Elsevier, vol. 10(1), pages 61-74.
    6. Bo Sandemann Rasmussen, "undated". "Credibility, Cost of Reneging and the Choice of Fixed Exchange Rate Regime," Economics Working Papers 2002-3, Department of Economics and Business Economics, Aarhus University.

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