Working Paper: CEPR ID: DP5876
Authors: Fernando A. Broner
Abstract: The first generation models of currency crises have often been criticized because they predict that, in the absence of very large triggering shocks, currency attacks should be predictable and lead to small devaluations. This paper shows that these features of first generation models are not robust to the inclusion of private information. In particular, this paper analyzes a generalization of the Krugman-Flood-Garber (KFG) model, which relaxes the assumption that all consumers are perfectly informed about the level of fundamentals. In this environment, the KFG equilibrium of zero devaluation is only one of many possible equilibria. In all the other equilibria, the lack of perfect information delays the attack on the currency past the point at which the shadow exchange rate equals the peg, giving rise to unpredictable and discrete devaluations.
Keywords: currency crises; discrete devaluations; first generation models; multiple equilibria; private information
JEL Codes: D8; E58; F31; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fraction of informed consumers (D19) | timing of currency crisis (F31) |
| uninformed consumers (D83) | unpredictability of currency crisis (F31) |
| fraction of informed consumers (D19) | likelihood of currency attacks (F31) |
| fraction of informed consumers (D19) | size of discrete devaluations (F31) |
| proportion of informed consumers (D18) | unpredictability of crises (H12) |
| unpredictability of crises (H12) | larger discrete devaluations (F31) |