The Dynamics of Financial Crises and the Risk to Defend the Exchange Rate
Despite major recent advance in the literature on financial crises, the key role of central banks in the dynamics of financial crises are still not well understood. Our aim is to contribute to a better understanding of the dynamics of financial crises by explicitly modeling the strategic options of both traders and central banks. We analyze a global game in which both speculative traders and the central bank face imperfect information. In case of an attack, the central bank basically faces three alternatives. It can either give in to the speculative attack or it can try to defend its exchange rate regime. If it chooses to defend its currency, the defense can be successful or not. In accordance with stylized facts for emerging markets, immediate devaluations are associated with costs in terms of higher (imported) inflation, successful interventions are followed by sluggish growth due to the underlying restrictive monetary policy while unsuccessful interventions typically result in both high inflation and a recession. Taken together, intervention is risky. If a central bank chooses to defend its currency it can avoid the costs of a devaluation in case the defense is successful. However, if it fails it faces the even higher costs of an (unsuccessful) defense and a devaluation, i.e. higher inflation and lower growth. In our global game approach, the strength of the realized defensive measures - in contrast to the potential defense - in general does not monotonously increase with the fundamental state. Thus global games attack models need to take into account the difference between the fundamentals themselves .i.e. the strength of the status quo or the defensive potential .and the optimal central bank reaction to an attack, i.e. the realized defensive measures.
|Date of creation:||2009|
|Contact details of provider:|| Postal: B IV, VWL, D-54286 Trier|
Phone: +49 (0) 651 201-2739
Fax: +49 (0) 651 201-3934
Web page: http://www.uni-trier.de/index.php?id=2118
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Frank Heinemann & Rosemarie Nagel & Peter Ockenfels, 2004. "The Theory of Global Games on Test: Experimental Analysis of Coordination Games with Public and Private Information," Econometrica, Econometric Society, vol. 72(5), pages 1583-1599, 09.
- Hyun Song Shin & Stephen Morris, 2001.
"Coordination Risk and the Price of Debt,"
FMG Discussion Papers
dp373, Financial Markets Group.
- Stephen Morris & Hyun Song Shin, 1999. "Coordination Risk and the Price of Debt," Cowles Foundation Discussion Papers 1241R, Cowles Foundation for Research in Economics, Yale University, revised Feb 2002.
- Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
- Stephen Morris & Hyun Song Shin, 1999. "Coordination Risk and the Price of Debt," Cowles Foundation Discussion Papers 1241, Cowles Foundation for Research in Economics, Yale University.
- Christian Bauer & Bernhard Herz & Volker Karb, 2006.
"Are twin currency and debt crises special?,"
019, Bavarian Graduate Program in Economics (BGPE).
- Herz, Bernhard & Bauer, Christian & Karb, Volker, 2006. "Are twin currency and debt crises special?," Proceedings of the German Development Economics Conference, Berlin 2006 11, Verein für Socialpolitik, Research Committee Development Economics.
- Robin Pope & Reinhard Selten & Sebastian Kube & Johannes Kaiser & JÃ¼rgen von Hagen, 2007.
"Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict,"
Bonn Econ Discussion Papers
bgse18_2007, University of Bonn, Germany.
- Robin Pope & Reinhard Selten & Sebastian Kube & Johannes Kaiser & JÃ¼rgen von Hagen, 2007. "Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict," Bonn Econ Discussion Papers bgse19_2007, University of Bonn, Germany.
- George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2007. "Dynamic Global Games of Regime Change: Learning, Multiplicity, and the Timing of Attacks," Econometrica, Econometric Society, vol. 75(3), pages 711-756, 05.
- Ho, Tai-Kuang & von Hagen, Jürgen, 2004.
"Money Market Pressure and the Determinants of Banking Crises,"
CEPR Discussion Papers
4651, C.E.P.R. Discussion Papers.
- Jürgen Von Hagen & Tai-Kuang Ho, 2007. "Money Market Pressure and the Determinants of Banking Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1037-1066, 08.
- von Hagen, Jürgen & Ho, Tai-kuang, 2004. "Money market pressure and the determinants of baning crises," ZEI Working Papers B 20-2004, University of Bonn, ZEI - Center for European Integration Studies.
- Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June.
- Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-325, August.
- Frankel, Jeffrey A. & Rose, Andrew K., 1996.
"Currency crashes in emerging markets: An empirical treatment,"
Journal of International Economics,
Elsevier, vol. 41(3-4), pages 351-366, November.
- Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
- Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
- Aaron Tornell & Frank Westermann (ed.), 2005.
"Boom-Bust Cycles and Financial Liberalization,"
MIT Press Books,
The MIT Press,
edition 1, volume 1, number 9780262201599.
- Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
- 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.
- Christian Bauer, 2005. "Solution Uniqueness In A Class Of Currency Crisis Games," International Game Theory Review (IGTR), World Scientific Publishing Co. Pte. Ltd., vol. 7(04), pages 531-543.
- M. Sbracia & Alessandro Prati, 2002.
"Currency Crises and Uncertainty About Fundamentals,"
IMF Working Papers
02/3, International Monetary Fund.
- Alessandro Prati & Massimo Sbracia, 2002. "Currency crises and uncertainty about fundamentals," Temi di discussione (Economic working papers) 446, Bank of Italy, Economic Research and International Relations Area.
- Lars E. O. Svensson, 2006. "Social Value of Public Information: Comment: Morris and Shin (2002) Is Actually Pro-Transparency, Not Con," American Economic Review, American Economic Association, vol. 96(1), pages 448-452, March.
- George-Marios Angeletos & Alessandro Pavan & Christian Hellwig, 2007. "Defense Policies Against Currency Attacks: on the Possibility of Predictions in a Global Game with Multiple Equilibria," Discussion Papers 1459, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
When requesting a correction, please mention this item's handle: RePEc:trr:wpaper:200903. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Matthias Neuenkirch)
If references are entirely missing, you can add them using this form.