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A Model of a Double Standard Exchange Rate System

Author

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  • Riku Kinnunen

    () (University of Liverpool)

Abstract

In this paper I propose a "double standard" fixed exchange rate system which will be shown to have a higher expected lifetime than a conventional fixed exchange rate system. I present a simple variant of the classic Flood-Garber-Krugman model where the domestic currency is pegged to one of the two foreign currencies, depending on which exchange rate is lower; intuitively, this system thus corresponds to a gradual inflation stabilization program which will start at a future time that is determined by the foreign exchange market instead of the government. This type of a conditional peg implies that the domestic money holdings have a higher expected return as compared with the standard fixed exchange rate system. Since at each period there is a non-zero probability for the appreciation of the domestic currency, the demand for it is thus higher which decreases the probability of a speculative attack and increases the expected lifetime of the fixed exchange rate.

Suggested Citation

  • Riku Kinnunen, 2003. "A Model of a Double Standard Exchange Rate System," Research Papers 2003_05, University of Liverpool Management School.
  • Handle: RePEc:liv:livedp:2003_05
    as

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    More about this item

    Keywords

    speculative attacks; fixed exchange rates;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • 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
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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