Working Paper: CEPR ID: DP2075
Authors: Olivier Loisel; Philippe Martin
Abstract: We analyse the effect of trade spillovers and of international coordination on currency crises. To do this, we present a model that builds on two separate literatures: the literature on international monetary cooperation on the one hand, and the literature on currency crises, or more precisely on the 'escape clause' approach of fixed exchange rate systems on the other hand. We show that the more important trade spillovers the more likely self-fulfilling speculative crises are and the larger the set of multiple equilibria. Coordination decreases the possibility of simultaneous self-fulfilling speculative crises in the region and reduces the set of multiple equilibria. However, regional coordination, even though welfare improving, makes countries more dependent on other countries' fundamentals so that it may induce more contagion: a negative shock in one country of the region increases the possibility of a currency crisis in the region because it reduces the feasibility of coordination.
Keywords: contagion; coordination; cooperation; fixed exchange rates; escape clause; exchange rate crisis; trade spillovers
JEL Codes: F33; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased trade spillovers (F69) | higher likelihood of self-fulfilling speculative currency crises (F31) |
| coordination among countries (F42) | reduced likelihood of simultaneous crises (H12) |
| coordination among countries (F42) | increased dependency on each other's economic fundamentals (F69) |
| negative shock in one country (F69) | raises the risk of a currency crisis in the region (F31) |
| coordination or cooperation (P11) | does not completely eliminate the risk of crises driven by self-fulfilling expectations (D84) |