Currency Crises and Foreign Reserves: A Simple Model
February 1, 2001
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Summary
This paper addresses the important question of how far a government will run down its stock of foreign reserves in a defense of a fixed exchange rate. An optimizing model of currency crisis is presented in which the decision of whether or not to borrow in a defense of a peg is explicitly analyzed. The threshold level of reserves is then determined endogenously and shown to be a function of fundamental economic variables. The analysis also demonstrates how an increase in the level of reserves, a credit-rating upgrade, or the imposition of capital controls can remove the multiplicity of equilibria.
Subject: Central banks, Conventional peg, Currencies, Currency crises, Depreciation, Foreign exchange, International reserves, Money, National accounts, Reserve positions
Keywords: Borrowing Reserves, capital control, Conventional peg, Currencies, Currency Crisis, currency defense, currency parity, Depreciation, depreciation expectation, government indifference boundary, International reserves, nominal exchange rate, open economy, peg hinge, rate of depreciation, Reserve positions, Speculative Attacks, WP
Pages:
24
Volume:
2001
DOI:
Issue:
018
Series:
Working Paper No. 2001/018
Stock No:
WPIEA0182001
ISBN:
9781451843644
ISSN:
1018-5941
