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Financial Fragility, Exchange-Rate Regimes, and Sudden Stops in a Small Open Economy

  • Wen-Yao Grace Wang

    ()

    (Texas A&M University at Galveston)

  • Paula Hernandez-Verme

    ()

    (Universidad de Guanajuato)

  • Raymond A. K. Cox Author E-mail: rcox@unbc.ca

    (University of Northern British Columbia)

We model a typical Asian economy in crisis using a dynamic general equilibrium technique and establishing exchange rates from nontrivial fiatcurrency demands. Sudden stops/bank panics are possible and are essential for evaluating the merits of alternative exchange-rate regimes. Strategic complementarities contribute to the severe indeterminacy of a continuum of equilibria. Social welfare and the scope of equilibria are also associated with the underlying policy regime and the built-in Sequential Checking Mechanism, including liquidity, solvency, and incentive-compatibility constraints in the model. Combining domestic and foreign reserve requirements promotes stability under a floating exchange-rate regime; however, this increases the scope for panic equilibria under both floating and fixed regimes. While backing the money supply reduces financial fragility under both systems, it only acts as a stabilizer in a fixed regime.

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Article provided by Turkish Economic Association in its journal Ekonomi-tek.

Volume (Year): 1 (2012)
Issue (Month): 3 (September)
Pages: 25-54

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Handle: RePEc:tek:journl:v:1:y:2012:i:3:p:25-54
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