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Instability in Exchange Rates of the World Leading Currencies: Implications of a Spatial Competition Model among Central Banks (Currencies, Competition, and Clans)

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  • Dirk Engelmann

    (CERGE-EI)

  • Jan Hanousek

    (CERGE-EI)

  • Evzen Kocenda

    (CERGE-EI)

Abstract

We use a spatial competition based model in a two-stage game setup to assess whether equilibrium in exchange rates among the leading currencies is attainable. We show that a stable equilibrium can be reached in the case of two leading currencies, but not in the case of three. In our model, central banks of leading currencies attract, through the workings of their objective and policy, small currencies that tie with leading currencies via exchange rate regimes. This can be thought of as a competition to link smaller currencies to a leading currency that is motivated by the fact that such a tie greatly reduces volatility within such an informal "currency area". Our theoretical findings are supported by empirical evidence. Since firms, traders, and countries currently recognize three leading currencies and their economic behavior reflects this, we may expect disagreement on overvaluation or undervaluation of certain currencies to continue.

Suggested Citation

  • Dirk Engelmann & Jan Hanousek & Evzen Kocenda, 2004. "Instability in Exchange Rates of the World Leading Currencies: Implications of a Spatial Competition Model among Central Banks (Currencies, Competition, and Clans)," Macroeconomics 0406003, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpma:0406003
    Note: Type of Document - pdf; pages: 33
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    Cited by:

    1. Aggarwal, Raj & Muckley, Cal B., 2010. "Assessing co-ordinated Asian exchange rate regimes: Proposal for a possible move towards a common currency," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(2), pages 149-165, April.
    2. Kang Chen & Chang Yee Kwan, 2015. "How are Exchange Rates Managed? Evidence of an Anchor-Based Heuristic," The World Economy, Wiley Blackwell, vol. 38(6), pages 1006-1014, June.

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    More about this item

    Keywords

    exchange rates; exchange rate regimes; central bank policy; monetary union; spatial competition;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development

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