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Financial Fragility, Exchange-Rate Regimes, and Sudden Stops in a Small Open Economy

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  • Wen-Yao Grace Wang

    ()
    (Texas A&M University at Galveston)

  • Paula Hernandez-Verme

    ()
    (Universidad de Guanajuato)

  • Raymond A. K. Cox Author E-mail: rcox@unbc.ca

    (University of Northern British Columbia)

Abstract

We model a typical Asian economy in crisis using a dynamic general equilibrium technique and establishing exchange rates from nontrivial fiatcurrency demands. Sudden stops/bank panics are possible and are essential for evaluating the merits of alternative exchange-rate regimes. Strategic complementarities contribute to the severe indeterminacy of a continuum of equilibria. Social welfare and the scope of equilibria are also associated with the underlying policy regime and the built-in Sequential Checking Mechanism, including liquidity, solvency, and incentive-compatibility constraints in the model. Combining domestic and foreign reserve requirements promotes stability under a floating exchange-rate regime; however, this increases the scope for panic equilibria under both floating and fixed regimes. While backing the money supply reduces financial fragility under both systems, it only acts as a stabilizer in a fixed regime.

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Bibliographic Info

Article provided by Turkish Economic Association in its journal Ekonomi-tek.

Volume (Year): 1 (2012)
Issue (Month): 3 (September)
Pages: 25-54

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Handle: RePEc:tek:journl:v:1:y:2012:i:3:p:25-54

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Keywords: Sudden stops; exchange-rate regimes; multiple reserve requirements;

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  1. Braggion, F. & Christiano, L. & Roldos, J., 2007. "Optimal Monetary Policy in a Sudden Stop," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3107633, Tilburg University.
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  3. Reinhart, Carmen & Calvo, Guillermo, 2000. "When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options," MPRA Paper 6982, University Library of Munich, Germany.
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  8. Vasco Cúrdia, 2008. "Optimal monetary policy under sudden stops," Staff Reports 323, Federal Reserve Bank of New York.
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