POLICY IMPLICATIONS OF 2ND-GENERATION CRISIS MODELS

After the speculative attacks on government-controlled exchange rates in Europe and in Mexico, economists began to develop models of currenc y crises with multiple solutions. In these models, a currency crisis o ccurs when the economy jumps suddenly from one solution to another. Th is paper examines one of the new models, as presented by Obstfeld (199 4), and finds that raising the cost of devaluation may make a crisis m ore likely. Consequently, slow convergence to a monetary union, which increases the cost to the government of reneging on an exchange rate p eg, may be counterproductive. This conclusion is exactly the opposite of that obtained from earlier models.