Non-Credible Intervention Commitments in a Fixed Exchange Rate System and the 1992-1993 EMS Crisis

Focusing on the 1992-93 crisis of the European Monetary System (Ems), I stress, in opposition with the conclusions reached by “escape clause” models, the role played by the availability of foreign reserves. In particular, I show the lack of credibility of the Bundesbank’s commitment to intervene in the foreign exchange market in defence of the Ems currencies subject to a speculative attack: the intervention commitment would have been fully credible only if the Bundesbank accepted to import the inflation rate of the partner countries. Moreover, although I prove that the Bundesbank’s optimal degree of intervention would have been higher if it could be sterilised, i.e. if it could be accompanied by a credit reduction, I argue that such a reduction would have caused an ambiguous effect on the timing of the speculative attack. Finally, this model shows that even when the fundamentals do not diverge when a country participates to a fixed exchange rate, the mere expectation of a divergent behaviour when exchange rates float freely may precipitate a currency crisis in a self-fulfilling way.