International macroe.. - Free

11.2. A SECOND GENERATION MODEL 3410.0160.0140.0120.010.0080.0060.004u0.002u-0.15 -0.13 -0.11 -0.09 -0.07 -0.05 -0.03 -0.01 0.01 0.03-0.0020Figure 11.2: Realignment thresholds for given δ e .Multiple trigger points for devaluation.u and ū depend on δ e . But the public also forms its expectationsconditional on the devaluation trigger points. This means that u, ūand δ e must be solved simultaneously.To simplify matters, we restrict attention to the case where the governmentmay either defend the Þx ordevalue the currency. Revaluationis not an option. We therefore focus on the devaluation threshold ū.We will set c r to be a very large number to rule out the possibility of arevaluation. The central bank’s devaluation rule is(δ0 =0 if uū . (11.39)Let P[X = x] be the probability of the event X = x. The expecteddepreciation isδ e = E 0 (δ)