How to manage speculative shocks: intra-European vs. International monetary coordination

Abstract

The literature on currency crisis has generally not answered to the following question: which economic policies may reduce the contagion effects of a speculative shock? We use a dynamic Mundell-Fleming model extended to four countries and compute three time-consistent equilibria: a Nash equilibrium, and Nash-bargaining equilibria, first between the central banks of the G3 (a target zone equilibrium) and, second between European governments and the ECB. The best equilibrium for the Fed, European and Japanese policymakers is intra-European coordination. It induces a very expansionary fiscal policy in the USA whose government hence rejects it. Extensions to the case of a Stability Pact in European countries do not alter our results. Introducing a Fed less conservative than the ECB or the BoJ provokes a change in US preferences: both authorities give priority to the monetary equilibrium and the US government is no longer isolationist.