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The Choice of Exchange Rate Regime and Speculative Attacks

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  • Cukierman, Alex
  • Spiegel, Yossi
  • Goldstein, Itay

Abstract

We develop a framework for studying the choice of exchange rate regime in an open economy where the local currency is vulnerable to speculative attacks. The framework makes it possible to study, for the first time, the strategic interaction between the ex ante choice of regime and the probability of ex post currency attacks. The optimal regime is determined by a policymaker who trades off the loss from nominal exchange rate uncertainty against the cost of maintaining a given regime. This cost is affected in turn by the likelihood of a speculative attack. Searching for the optimal regime within the class of exchange rate bands, we show that the optimal regime is either a peg (a zero-width band), a free float (an infinite-width band), or a non-degenerate finite-width band. Our framework generates several novel predictions and shows that when the endogeneity of the exchange rate regime is recognized explicitly, conventional wisdom may be reversed. For instance, the imposition of a Tobin tax, by inducing policymakers to set less flexible regimes, may raise the likelihood of speculative attacks.

Suggested Citation

  • Cukierman, Alex & Spiegel, Yossi & Goldstein, Itay, 2003. "The Choice of Exchange Rate Regime and Speculative Attacks," CEPR Discussion Papers 3714, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:3714
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    2. 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.
    3. Iljoong Kim & Inbae Kim, 2005. "Endogenous changes in the exchange rate regime: A bureaucratic incentive model," Public Choice, Springer, vol. 125(3), pages 339-361, December.
    4. Richard K. Lyons & Ganesh Viswanath-Natraj, 2020. "What Keeps Stablecoins Stable?," NBER Working Papers 27136, National Bureau of Economic Research, Inc.
    5. Dzsamila Vonnak, 2018. "Multidimensional global games and some applications," CERS-IE WORKING PAPERS 1803, Institute of Economics, Centre for Economic and Regional Studies.
    6. Leila Ali, 2012. "Flexibility: Stability's Best Friend in Non-transparent Countries?," International Economic Journal, Taylor & Francis Journals, vol. 26(2), pages 247-264, December.
    7. Basteck, Christian & Daniëls, Tijmen R. & Heinemann, Frank, 2013. "Characterising equilibrium selection in global games with strategic complementarities," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2620-2637.

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    More about this item

    Keywords

    Currency crises; Choice of exchange rate regime; Speculators; Tobin tax; Global games; Reputation;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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