This paper shows that in a small open economy model with downward nominal wage rigidity pegging the nominal exchange rate creates a negative pecuniary externality. This peg-induced externality is shown to cause unemployment, overborrowing, and depressed levels of consumption. The paper...

A salient characteristic of sovereign defaults is that they are typically accompanied by large devaluations. This paper presents new evidence of this empirical regularity known as the Twin Ds and proposes a model that rationalizes it as an optimal policy outcome. The model combines limited...

This paper studies the relationship between financial structure and the welfare consequences of fixed exchange rate regimes in small open emerging economies with downward nominal wage rigidity. The paper presents two surprising results. First, a pegging economy might be better off with a closed...

The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed at...

Using an optimizing model of a small open economy, this paper studies the macroeconomic effects of PPP rules whereby the government increases the devaluation rate when the real exchange rate defined as the price of tradables in terms of nontradables is below its long-run level and reduces the...

We identify a disconnect between historical and model-based assessments of the costs of currency pegs due to nominal rigidities. While the former attribute major contractions and massive unemployment to currency pegs, the latter find miniscule welfare losses. The goal of this paper is to...

In his seminal 1960 article Robert Mundell proposed a model of balance-of-payments crises in which confidence in the continuation of a currency peg depended on the observed holdings of central bank foreign reserves. We examine the implications of a reformulation of this view from the perspective...

This paper shows that the risk of devaluation can be an important factor accounting for the stylized facts of exchange-rate-based stabilizations. This conclusion follows from studying the quantitative implications of a two-sector equilibrium business cycle model of a small open economy...