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The Choice of Exchange Rate Regime and Speculative Attacks

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  • Cukierman, Alex
  • Goldstein, Itay
  • Spiegel, Yossi

Abstract

We develop a framework for studying the choice of exchange rate regime in an open economy where the local currency is vulnerable to speculative attacks. The framework makes it possible to study, for the first time, the strategic interaction between the ex ante choice of regime and the probability of ex post currency attacks. The optimal regime is determined by a policymaker who trades off the loss from nominal exchange rate uncertainty against the cost of maintaining a given regime. This cost is affected in turn by the likelihood of a speculative attack. Searching for the optimal regime within the class of exchange rate bands, we show that the optimal regime is either a peg (a zero-width band), a free float (an infinite-width band), or a non-degenerate finite-width band. Our framework generates several novel predictions and shows that when the endogeneity of the exchange rate regime is recognized explicitly, conventional wisdom may be reversed. For instance, the imposition of a Tobin tax, by inducing policymakers to set less flexible regimes, may raise the likelihood of speculative attacks.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3714.

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Date of creation: Jan 2003
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Handle: RePEc:cpr:ceprdp:3714

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Keywords: choice of exchange rate regime; currency crises; global games; reputation; speculators; tobin tax;

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References

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Citations

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Cited by:
  1. Tijmen Daniëls & Henk Jager & Franc Klaassen, 2009. "Defending Against Speculative Attacks," SFB 649 Discussion Papers SFB649DP2009-011, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  2. Agnès Bénassy-Quéré & Benoit Coeuré, 2002. "The Survival of Intermediate Exchange Rate Regimes," Working Papers 2002-07, CEPII research center.
  3. Iljoong Kim & Inbae Kim, 2005. "Endogenous changes in the exchange rate regime: A bureaucratic incentive model," Public Choice, Springer, Springer, vol. 125(3), pages 339-361, December.
  4. Basteck, Christian & Daniëls, Tijmen R. & Heinemann, Frank, 2013. "Characterising equilibrium selection in global games with strategic complementarities," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2620-2637.
  5. Pathak, Parag & Tirole, Jean, 2006. "Speculative Attacks and Risk Management," IDEI Working Papers 438, Institut d'Économie Industrielle (IDEI), Toulouse.

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