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The "Gold Standard Paradox" and its Resolution

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  • Willem H. Buiter
  • Vittorio U. Grilli

Abstract

This paper analyzes Krugman's contention that there is a "gold standard paradox" in the speculative attack literature. The paradox occurs if a country's currency appreciates after it runs out of gold or equivalently if a speculative attack can happen only after the country "naturally" runs out of reserves. We first show that Krugman's paradox is a very general phenomenon which does not require mean reverting processes for the fundamentals and which can be present in discrete time models as well as in continuous time models. We present several specific cases in which the paradox occurs i.e. environments which do not support an equilibrium. Next we show that, contrary to Krugman's conjecture, it is not necessary to abandon the assumption of a perfectly fixed exchange rate in favor of a band system in order to recover a well-defined equilibrium. We propose two alternative ways of amending the model which produce an equilibrium and preserve the fixed exchange rate assumption.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3178.

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Date of creation: Nov 1989
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Publication status: published as Paul Krugman and Marcus Miller, editors, "Anomalous Speculative Attacks on Fixed Exchange Rate Regimes," Exchange Rates and Currency Bands. Cambridge University Press, forthcoming 1991.
Handle: RePEc:nbr:nberwo:3178

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  1. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
  2. Robert P. Flood & Peter M. Garber, 1989. "The Linkage Between Speculative Attack and Target Zone Models of Exchange Rates," NBER Working Papers 2918, National Bureau of Economic Research, Inc.
  3. Buiter, Willem H, 1986. "Borrowing to Defend the Exchange Rate and the Timing and Magnitude of Speculative Attacks," CEPR Discussion Papers 95, C.E.P.R. Discussion Papers.
  4. Paul R. Krugman, 1987. "Trigger Strategies and Price Dynamics in Equity and Foreign Exchange Markets," NBER Working Papers 2459, National Bureau of Economic Research, Inc.
  5. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
  6. Kenneth A. Froot & Maurice Obstfeld, 1989. "Stochastic Process Switching: Some Simple Solutions," NBER Working Papers 2998, National Bureau of Economic Research, Inc.
  7. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
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Cited by:
  1. Lars E.O. Svensson, 1989. "Target Zones and Interest Rate Variability," NBER Working Papers 3218, National Bureau of Economic Research, Inc.
  2. Bernard Dumas & Lars E.O. Svensson, 1991. "How Long do Unilateral Target Zones Last?," NBER Working Papers 3931, National Bureau of Economic Research, Inc.
  3. James Bullard, 1991. "Collapsing exchange rate regimes: a reinterpretation," Working Papers 1991-003, Federal Reserve Bank of St. Louis.

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