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Endogenous inflows of speculative capital and the optimal currency appreciation path

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  • Mei Li
  • Junfeng Qiu

Abstract

This 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. Ce mémoire examine le sentier optimal d'appréciation d'une monnaie sous‐évaluée quand il y a des flux de capitaux spéculatifs qui sont affectés de manière endogène par la nature du sentier. Une banque centrale décide de sa politique d'appréciation à partir de la prise en compte de trois coûts : (i) les coûts de désalignement associés à l'écart entre les taux de change actuels et ceux qui correspondent à l'équilibre de long terme, (ii) les coûts d'ajustement attribuables à la réallocation des ressources, et (iii) les pertes de capital attribuables aux flux de capitaux spéculatifs. On découvre que (1) quand les spéculateurs ne font pas face à des chocs de liquidité, la banque centrale tend à apprécier la monnaie rapidement pour décourager le capital spéculatif; (2) quand les spéculateurs font face à des chocs de liquidité, la banque centrale se pré‐engage optimalement à suivre un sentier d'appréciation plus lent, et l'appréciation prend le plus de temps quand la probabilité de chocs d'appréciation a des valeurs intermédiaires; (3) la banque centrale tend à faire s'apprécier la monnaie plus rapidement quand elle mène une politique discrétionnaire.

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  • Mei Li & Junfeng Qiu, 2011. "Endogenous inflows of speculative capital and the optimal currency appreciation path," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 44(1), pages 364-379, February.
    • Handle: RePEc:wly:canjec:v:44:y:2011:i:1:p:364-379
    DOI: 10.1111/j.1540-5982.2010.01636.x
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    1. Mei Li & Junfeng Qiu, 2011. "Endogenous inflows of speculative capital and the optimal currency appreciation path," Canadian Journal of Economics, Canadian Economics Association, vol. 44(1), pages 364-379, February.
    2. 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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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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