NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Explaining the Duration of Exchange-Rate Pegs

Michael W. Klein, Nancy P. Marion

NBER Working Paper No. 4651
Issued in February 1994
NBER Program(s):   IFM

This paper is a theoretical and empirical investigation into the duration of exchange-rate pegs. The theoretical model considers a policy-maker who must trade off the economic costs of real exchange- rate misalignment against the political cost of realignment. The optimal time to spend on a peg is derived and factors that influence peg duration are identified. The predictions of the model are tested using logit analysis with a data set of exchange-rate pegs for sixteen Latin American countries and Jamaica during the 1957-1991 period. We find that the real exchange rate is a significant determinant of the likelihood of a devaluation. Structural variables, such as the openness of the economy and its geographical trade concentration, also significantly affect the likelihood of a devaluation. Finally, political events that change the political cost of realignment, such as regular and irregular executive transfers, are empirically important determinants of the likelihood of a devaluation.

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Document Object Identifier (DOI): 10.3386/w4651

Published: Journal of Development Economics, Vol. 54, no. 2 (December 1997): 387-404.

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