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Currency crises with the threat of an interest rate defence

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  • Daniëls, Tijmen R.
  • Jager, Henk
  • Klaassen, Franc

Abstract

While virtually all currency crisis models recognise that the decision to abandon a peg depends on how tenaciously policy makers defend it, this is seldom modelled explicitly. We add the threat of an interest rate defence to the global game model of Morris and Shin (American Economic Review 88, 1998). With an endogenous defence, actions of speculators may become strategic substitutes instead of the usual complements. Nevertheless, our generalised model remains tractable and has a unique threshold equilibrium. It provides additional insights. For instance, the threat of an interest rate defence makes speculation riskier and this may be sufficient to keep speculators out when fundamentals are still relatively strong.

Suggested Citation

  • Daniëls, Tijmen R. & Jager, Henk & Klaassen, Franc, 2011. "Currency crises with the threat of an interest rate defence," Journal of International Economics, Elsevier, vol. 85(1), pages 14-24, September.
  • Handle: RePEc:eee:inecon:v:85:y:2011:i:1:p:14-24
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    3. Bauer, Christian & Ernstberger, Philip, 2014. "The Dynamics of Currency Crises - Results from Intertemporal Optimization and Viscosity Solutions," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100300, Verein für Socialpolitik / German Economic Association.
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    More about this item

    Keywords

    Currency crisis Interest rate defence Global game Strategic substitutes;

    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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