Introduction Recent experience seems to confirm the impression that currency crises, triggered by speculative attacks, are an inevitable characteristic of fixed exchange rate regimes. Within the economics profession there is, however, a strong controversy about the causes and nature of such attacks.
Panglossian economists like to argue that they are ultimately driven by weak fundamentals.
By attacking when fundamentals are weak, speculation imposes the market discipline required to correct an unsustainable policy regime of fixed exchange rates. On the other hand, if speculators believe that devaluation is likely to occur, they are inclined to attack, and this attack will trigger the devaluation. Under multiple equilibria expectations are self-fulfilling. Thus, there exists a continuum of equilibria with self fulfilling beliefs. The fate of the economy seems to be in the hands of arbitrary expectations of speculators - irrespective of the soundness of policy variables.