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The Choice of Exchange-Rate Regime and Speculative Attacks

  • Alex Cukierman

    (Tel Aviv University and Tilburg University,)

  • Itay Goldstein

    (Wharton School, University of Pennsylvania,)

  • Yossi Spiegel

    (Tel Aviv University,)

We develop a framework that makes it possible to study, for the first time, the strategic interac-tion between the ex ante choice of exchange-rate regime and the likelihood of ex post currency attacks. The optimal regime is determined by a policymaker who trades off the loss from nom-inal exchange-rate uncertainty against the cost of adopting a given regime. This cost increases, in turn, with the fraction of speculators who attack the local currency. Searching for the optimal regime within the class of exchange-rate bands, we show that the optimal regime can be either a peg (a zero-width band), a free float (an infinite-width band), or a nondegenerate band of finite width. We study the effect of several factors on the optimal regime and on the probability of currency attacks. In particular, we show that a Tobin tax induces policymakers to set less flexible regimes. In our model, this generates an increase in the probability of currency attacks. (JEL: F31, D84) Copyright (c) 2004 by the European Economic Association.

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Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 2 (2004)
Issue (Month): 6 (December)
Pages: 1206-1241

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Handle: RePEc:tpr:jeurec:v:2:y:2004:i:6:p:1206-1241
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