There are two categories of models to study breakdowns of fixed exchange rate regimes: The first focuses on the mechanics of private speculative attacks when underlying monetary policies are inconsistent with the indefinite survival of fixed exchange rates. The second views the decision to defend or abandon an exchange rate peg as a rational policy choice, expressed as a contingent rule. Discussion Paper No. 1201, written by Research Fellow Willem Buiter, Giancarlo Corsetti and Paolo Pesenti, falls into the latter category since it regards the defence or abandonment of a fixed rate parity as the application of an optimal contingent policy rule by a national monetary authority.

The main focus of the model employed is on the decisive role played by the coordination (or lack of it) of monetary policies among national policy-makers in the analysis of the demise of a fixed exchange rate regime. Timing, frequency and magnitude of exchange rate realignments are studied in a stylized multi-country centre-periphery set-up. Assumptions appropriate to simulating the ERM are made about the nature of the game. Two ways in which a generalized crisis of the exchange rate system may emerge are isolated. It is claimed that, despite its highly stylized nature, the model provides a useful framework for the interpretation of the collapse of the ERM in 1992-3, since it depicts the lack of cooperation between the Frankfurt-based centre and the periphery consisting of the rest of the ERM.

A Centre-Periphery Model of Monetary Coordination and Exchange Rate Crises
Willem E. Buiter, Giancarlo Corsetti and Paolo A. Pesenti

Discussion Paper No. 1201, July 1995 (IM)