DESTABILIZING EFFECTS OF EXCHANGE-RATE ESCAPE CLAUSES

This paper studies policy rules with escape clauses, analyzing as an e xample fixed exchange rate systems that allow member countries the fre edom to realign in periods of stress. While well-designed, escape-clau se rules can raise society's welfare in principle, limited credibility makes it difficult to implement such rules in practice. An EMS-type i nstitution that imposes political costs on policymakers who realign ma y raise welfare, but can also produce equilibria far inferior to an ir revocably fixed exchange rate. Switches between multiple equilibria ma y have the character of sudden speculative attacks. (C) 1997 Elsevier Science B.V.