WHEN ARE FIXED EXCHANGE-RATES REALLY FIXED

This paper analyzes the sustainability of fixed exchange rates by exte nding the time inconsistency framework to a fully dynamic context in w hich the level of a state variable (in this case debt) determines the payoffs available to the government at each point in time. The model y ields the following results. If debt is sufficiently low, there is an equilibrium in which the government does not devalue. For an intermedi ate range of debt levels, the government devalues in response to an at tack but not otherwise, so that self-fulfilling attacks can occur. Fin ally, for yet another debt range there can also be sunspot equilibria in which an attack (and the corresponding devaluation) occurs with pos itive probability. (C) 1997 Elsevier Science B.V.