The "Gold Standard Paradox" and its Resolution
This paper analyzes Krugman's contention that there is a "gold standard paradox" in the speculative attack literature. The paradox occurs if a country's currency appreciates after it runs out of gold or equivalently if a speculative attack can happen only after the country "naturally" runs out of reserves. We first show that Krugman's paradox is a very general phenomenon which does not require mean reverting processes for the fundamentals and which can be present in discrete time models as well as in continuous time models. We present several specific cases in which the paradox occurs i.e. environments which do not support an equilibrium. Next we show that, contrary to Krugman's conjecture, it is not necessary to abandon the assumption of a perfectly fixed exchange rate in favor of a band system in order to recover a well-defined equilibrium. We propose two alternative ways of amending the model which produce an equilibrium and preserve the fixed exchange rate assumption.
|Date of creation:||Nov 1989|
|Date of revision:|
|Publication status:||published as Paul Krugman and Marcus Miller, editors, "Anomalous Speculative Attacks on Fixed Exchange Rate Regimes," Exchange Rates and Currency Bands. Cambridge University Press, forthcoming 1991.|
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"The Linkage between Speculative Attack and Target Zone Models of Exchange Rates,"
The Quarterly Journal of Economics,
MIT Press, vol. 106(4), pages 1367-72, November.
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- Froot, Kenneth A & Obstfeld, Maurice, 1991.
"Stochastic Process Switching: Some Simple Solutions,"
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- Kenneth A. Froot & Maurice Obstfeld, 1989. "Stochastic Process Switching: Some Simple Solutions," NBER Working Papers 2998, National Bureau of Economic Research, Inc.
- Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
- Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
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