How To Avoid Self-fulfilling Crises

Obstfeld (1994) shows that a currency crisis can be explained by the occurrence of multiple equi-libria (2 interior equilibria). For the same level of economic fundamentals, it may be optimal forthe government either to devalue or to maintain the peg. The decision depends on the inßationaryexpectations of economic agents: it is the phenomenon of self-fulÞlling crisis. In order to avoid thiskind of crisis, this article offers a new proposal: a partial delegation of exchange rate policy to a moreinßation-averse central banker. It shows that if the government continues to decide whether to main-tain the peg while the central banker chooses the magnitude of any realignment, lower inßationaryexpectations will lead to the existence of only one equilibrium. The probability of crisis will then beconsiderably reduced and a currency crisis will occur only if negative shocks substantially damage thelevel of economic fundamentals.