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Robert P. Flood, Nancy P. Marion
NBER Working Paper No. 5789
Issued in October 1996
NBER Program(s): IFM
---- Abstract -----
We develop a modified understand better the 1994 Mexican peso crisis as well as aspects of the European currency crises in 1992-93. We introduce the assumption that the speculative attack is sterilized by the domestic monetary authority, we incorporate a stochastic risk premium, and we allow for some price stickiness. The modified model shows that macroeconomic policies inconsistent in the longer run with a fixed exchange rate can push the economy inevitably towards a currency crisis, but it also demonstrates how a government currently following consistent macroeconomic policies can suddenly face a speculative attack triggered by a large shift in speculative opinion. However, the ability of a sudden shift in speculative opinion to trigger an attack is bounded by the position of fundamentals. Thus an attack does not require a later change in policies to make it profitable.
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