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IMF Staff Papers Logo    Last updated: April 2005
Volume 52, Number 1
 
Interdependent Expectations and the Spread of Currency Crises
Wolfram Berger and Helmut Wagner

Full Text of this Article (PDF 97K)

Abstract: In this paper we analyze how the mutual interdependence of private sector expectations influences the stability of fixed exchange rate regimes in different countries. When countries trade with one another, the crisis probabilities are interdependent because monetary policy in each country affects welfare both at home and abroad. Wage setters react to a trading partner’s imminent crisis, because a loss of international competitiveness changes their governments’ optimal escape clauses. Thus, not only actual devaluations but an increasing crisis probability in one country may trigger currency crises elsewhere. We show that both fundamental weakness and spontaneous shifts in market sentiment may play a role in the transmission of currency crises.
[JEL F33, F41, E58]