DP2075 Coordination, Cooperation, Contagion and Currency Crises

Author(s): Olivier Loisel, Philippe Martin
Publication Date: February 1999
Keyword(s): Contagion, Cooperation, Coordination, Escape Clause, Exchange Rate Crisis, Fixed Exchange Rates, trade spillovers
JEL(s): F33, F41, F42
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2075

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.