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Defending Against Speculative Attacks

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Author Info
Tijmen Daniëls
Henk Jager
Franc Klaassen

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Abstract

While virtually all currency crisismodels recognise that the fate of a currency peg depends on how tenaciously policy makers defend it, they seldom model how this is done. We incorporate themechanics of speculation and the interest rate defence against it in the model ofMorris and Shin (American Economic Review 88, 1998). Our model captures that the interest rate defence reduces speculators’ profits and thus postpones the crisis. It predicts that well before the fall of a currency interest rates are increased to offset the buildup of exchange market pressure, and this then unravels in a sharp depreciation. This pattern is at odds with predictions of standard models, but we show that it fits well with reality.

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Publisher Info
Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2009-011.

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Length: 34 pages
Date of creation: Feb 2009
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Handle: RePEc:hum:wpaper:sfb649dp2009-011

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Related research
Keywords: Exchange Market Pressure; Currency Crisis; Interest Rate Defence; Global Game;

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Find related papers by JEL classification:
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F31 - International Economics - - International Finance - - - Foreign Exchange
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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References listed on IDEAS
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  19. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
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  22. George-Marios Angeletos & Alessandro Pavan & Christian Hellwig, 2007. "Defense Policies Against Currency Attacks: on the Possibility of Predictions in a Global Game with Multiple Equilibria," Discussion Papers 1459, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  25. Broner, Fernando A., 2008. "Discrete devaluations and multiple equilibria in a first generation model of currency crises," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 592-605, April. [Downloadable!] (restricted)
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  26. Botman, Dennis P. J. & Jager, Henk, 2002. "Coordination of speculation," Journal of International Economics, Elsevier, vol. 58(1), pages 159-175, October. [Downloadable!] (restricted)
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  31. Jeanne, Olivier, 1999. "Currency Crises: A Perspective on Recent Theoretical Developments," CEPR Discussion Papers 2170, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  32. Drazen, Allan, 2000. "Interest-rate and borrowing defense against speculative attack," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 303-348, December. [Downloadable!] (restricted)
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  34. Jeanne, Olivier & Masson, Paul, 2000. "Currency crises, sunspots and Markov-switching regimes," Journal of International Economics, Elsevier, vol. 50(2), pages 327-350, April. [Downloadable!] (restricted)
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