DP969 Shocks and the Viability of a Fixed Exchange Rate Commitment

Author(s): Torben M Andersen
Publication Date: June 1994
Keyword(s): Commitment, Fixed Exchange Rates, Regime Shifts, State Dependence
JEL(s): F31, F33
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=969

The incentive to renege on a commitment to a fixed exchange rate is shown to be state contingent. A fixed exchange rate policy is not viable under `unusual' circumstances, and the incentive to violate the commitment is larger in the case of contractionary shocks than in the case of expansionary shocks. The possibility that the exchange rate regime is changed in `unusual' circumstances also has significant effects under `normal' circumstances, implying systematic devaluation expectations and output losses.