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The Choice of Exchange-Rate Regime and Speculative Attacks

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Author Info
Alex Cukierman (Tel Aviv University and Tilburg University,)
Itay Goldstein (Wharton School, University of Pennsylvania,)
Yossi Spiegel (Tel Aviv University,)

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Abstract

We develop a framework that makes it possible to study, for the first time, the strategic interac-tion between the ex ante choice of exchange-rate regime and the likelihood of ex post currency attacks. The optimal regime is determined by a policymaker who trades off the loss from nom-inal exchange-rate uncertainty against the cost of adopting a given regime. This cost increases, in turn, with the fraction of speculators who attack the local currency. Searching for the optimal regime within the class of exchange-rate bands, we show that the optimal regime can be either a peg (a zero-width band), a free float (an infinite-width band), or a nondegenerate band of finite width. We study the effect of several factors on the optimal regime and on the probability of currency attacks. In particular, we show that a Tobin tax induces policymakers to set less flexible regimes. In our model, this generates an increase in the probability of currency attacks. (JEL: F31, D84) Copyright (c) 2004 by the European Economic Association.

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Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 2 (2004)
Issue (Month): 6 (December)
Pages: 1206-1241
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Handle: RePEc:tpr:jeurec:v:2:y:2004:i:6:p:1206-1241

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Agnes Benassy-Quere & Benoit Cœure, 2002. "The Survival of Intermediate Exchange Rate Regimes," Working Papers 2002-07, CEPII research center. [Downloadable!]
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  2. Iljoong Kim & Inbae Kim, 2005. "Endogenous changes in the exchange rate regime: A bureaucratic incentive model," Public Choice, Springer, vol. 125(3), pages 339-361, December. [Downloadable!] (restricted)
  3. Pathak, Parag & Tirole, Jean, 2006. "Speculative Attacks and Risk Management," IDEI Working Papers 438, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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