Rational and Self-Fulfilling Balance-of-Payments Crises.

The collapse of a fixed exchange rate is typically marked by one or more balance of payments crises in which speculators acquire a large portion of the central bank's foreign reserves as the bank attempts in vain to support its currency. Economists have long attributed such crises to inappropriate domestic policies that ultimately place the central bank in the uncomfortable position of offering speculators a one-sided bet. When asset holders have perfect foresight and the current peg must eventually be abandoned, profit maximization dictates that a sharp attack on the central bank's reserves occur at some point on the economy's path. This article demonstrates the existence of circumstances in which balance of payments crises may indeed be purely self-fulfilling events rather than the inevitable result of unsustainable macroeconomic policies. Such crises are apparently unnecessary and collapse an exchange rate that would otherwise have been viable. They reflect not irrational private behavior, but an indeterminacy of equilibrium that may arise when agents expect a speculative attack to cause a sharp change in government macroeconomic policies.