EXPECTATIONS AND CONTAGION IN SELF-FULFILLING CURRENCY ATTACKS

Self-fulfilling expectations are commonly believed to play an important role in the transmission of currency crises across countries. Formal models of contagion based on multiple equilibria, however, have been criticized for failing to explain basic patterns observed in the data; these criticisms have been taken as evidence against the self-fulfilling view. This article argues that the importance of self-fulfilling beliefs is not so easily dismissed. A slightly richer model, based on the incomplete-information framework of Morris and Shin ("American Economic Review" 88 (1998), 587-97) , can generate contagion due to self-fulfilling beliefs while placing restrictions on observable variables that are broadly consistent with the empirical evidence. Copyright © (2009) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.