Spreading Currency Crises: The Role of Economic Interdependence

21 Pages Posted: 1 Feb 2006

See all articles by Wolfram Berger

Wolfram Berger

Fernuniversitaet Hagen

Helmut Wagner

University of Hagen (Fernuniversitaet Hagen)

Date Written: August 2002

Abstract

We analyze in this paper how the mutual dependence of private sector expectations in different countries on one another influences the stability of fixed exchange rate regimes. The crisis probabilities of countries trading with one another are interdependent because wage setters react to an imminent loss of international competitiveness stemming from an increase in the crisis probability of a trading partner. If a currency crisis in one country is perceived to be increasingly likely, the probability of devaluation of its trading partners' currencies to restore their international competitiveness rises as well. Thus, not only actual devaluations but also an increasing crisis probability may trigger currency crises elsewhere. We show that not only fundamental weaknesses but also spontaneous shifts in market sentiment may play a role in precipitating currency crises.

Keywords: currency crisis, trade links, fixed exchange rates, multiple equilibria, self-fulfilling expectations

JEL Classification: F33, F41, E58

Suggested Citation

Berger, Wolfram and Wagner, Helmut, Spreading Currency Crises: The Role of Economic Interdependence (August 2002). IMF Working Paper No. 02/144, Available at SSRN: https://ssrn.com/abstract=879945

Wolfram Berger (Contact Author)

Fernuniversitaet Hagen ( email )

Universitätsstrasse 41
Feithstrathe 140
D-58084 Hagen
Germany

Helmut Wagner

University of Hagen (Fernuniversitaet Hagen) ( email )

Universitätsstrasse 41
Feithstrathe 140
D-58084 Hagen
Germany
011-49-2331-987-2640 (Phone)
011-49-2331-987-391 (Fax)

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