Endogenous inflows of speculative capital and the optimal currency appreciation path
AbstractThis paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long-run equilibrium exchange rates, (ii) short-term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre-commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values; (3) the central bank tends to appreciate the currency more quickly when it conducts discretionary policy.
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Bibliographic InfoArticle provided by Canadian Economics Association in its journal Canadian Journal of Economics.
Volume (Year): 44 (2011)
Issue (Month): 1 (February)
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Other versions of this item:
- Mei Li, & Junfeng Qiu, 2009. "Endogenous Inflows of Speculative Capital and the Optimal Currency Appreciation Path," Working Papers 0905, University of Guelph, Department of Economics and Finance.
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
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- Li, Mei & Qiu, Junfeng, 2013. "Speculative capital inflows, adaptive expectations, and the optimal renminbi appreciation policy," China Economic Review, Elsevier, vol. 25(C), pages 117-138.
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