In his seminal 1960 study on the dynamics of alternative exchange rate regimes, Robert
Mundell proposed a theory of balance-of-payments crises in which speculators base their actions
on the observed holdings of central bank foreign reserves. We examine the quantitative implications
of this view from the perspective of an equilibrium business cycle model in which rational
expectations of a devaluation are conditioned on foreign reserves. The model explains some of the
empirical regularities of the business cycle associated with temporary fixed-exchange-rate regimes.
In turn, these cyclical dynamics validate the agents' expectations by producing devaluation
probabilities that resemble those estimated from the data. The model thus aims to explain both the
real effects and the collapse of exchange-rate-based stabilizations in a unified framework.
Full paper (308 KB PDF)
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