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A Theory of Currency Board with Irrevocable Commitments

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  • Alex W. H. Chan
  • Nai‐fu Chen

Abstract

Currency boards are subject to runs if the foreign currency reserve is insufficient to back the convertible money supply. We construct a simple model and show how pre‐specified optimal reserve commitments can avert currency board runs. If there exists asymmetric information on the government's resolve, the government can also use commitments as a costly signal to induce a separating equilibrium. The model can be adapted to analyze other hard‐fixed exchange rate systems such as dollarizations and monetary unions. We illustrate the implications of our model in terms of the recent success in Hong Kong and possible remedies for Argentina.

Suggested Citation

  • Alex W. H. Chan & Nai‐fu Chen, 2003. "A Theory of Currency Board with Irrevocable Commitments," International Review of Finance, International Review of Finance Ltd., vol. 4(3‐4), pages 125-170, September.
    • Handle: RePEc:bla:irvfin:v:4:y:2003:i:3-4:p:125-170
    DOI: 10.1111/j.1468-2443.2005.00045.x
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    References listed on IDEAS

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    1. Mr. Peter Breuer, 1999. "Central Bank Participation in Currency Options Markets," IMF Working Papers 1999/140, International Monetary Fund.
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    1. repec:zbw:bofitp:2009_021 is not listed on IDEAS
    2. Chen, Yu-Fu & Funke, Michael & Glanemann, Nicole, 2009. "A Soft Edge Target Zone Model: Theory And Application To Hong Kong," SIRE Discussion Papers 2009-61, Scottish Institute for Research in Economics (SIRE).
    3. Michael Funke & Yu-Fu Chen & Nicole Glanemann, 2009. "A soft target zone model: Theory and application to Hong Kong," Quantitative Macroeconomics Working Papers 20912, Hamburg University, Department of Economics.
    4. Yu-Fu Chen & Michael Funke & Nicole Glanemann, 2009. "A Soft Edge Target Zone Model: Theory And Application To Hong Kong," Dundee Discussion Papers in Economics 228, Economic Studies, University of Dundee.

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