While Europe has moved into recovery, many of the fundamental, long-term economic indicators have not changed. Unemployment rates of Belgium, Denmark and France remain in double digits, Belgium's debt still exceeds its annual GDP. Thus, in Discussion Paper No. 1315, Research Fellow Maurice Obstfeld takes the view that the exchange rate record throws doubt on the applicability to these countries of classical theories of rational speculative attack, in which a fixed exchange rate contains inflationary pressures which ultimately explode in a sudden balance-of-payments crisis that frees the currency to depreciate.

A newer generation of crisis models, whose focus is on governments' continuous comparison of the net benefits from changing the exchange rate versus defending it, appears to be more appropriate, suggesting that even sustainable currency pegs may be attacked and broken. After exploring strategic considerations underlying speculative attack models and describing an illustrative model in which high unemployment may cause an exchange rate crisis with self-fulfilling features, the paper reviews some other self-reinforcing mechanisms.

Models of Currency Crises with Self-fulfilling Features
Maurice Obstfeld