The Choice of Exchange Rate Regime and Speculative Attacks

43 Pages Posted: 1 Mar 2002

See all articles by Alex Cukierman

Alex Cukierman

Tel Aviv University - Eitan Berglas School of Economics; Interdisciplinary Center (IDC) Herzliyah; Centre for Economic Policy Research (CEPR)

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Yossi Spiegel

Tel Aviv University, Coller School of Management; Centre for Economic Policy Research (CEPR); ZEW – Leibniz Centre for European Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: February 9, 2002

Abstract

We develop a framework for studying the choice of exchange rate regime in an open economy where the local currency is vulnerable to speculative attacks. The optimal regime is determined by a policymaker who trades off the loss from nominal exchange rate uncertainty, against the cost of maintaining a given regime. This cost is affected in turn by the likelihood of a speculative attack. Searching for the optimal regime within the class of exchange rate bands, we show that the optimal regime is either a peg (a zero-width band), a free float (an infinite-width band), or a non degenerate finite width band. In the latter case, the exchange rate is allowed to move freely only within a band set around some center rate. We examine the determinants of the optimal band width and show, among other things, that, ceteris paribus, lower costs of moving across currencies induce policymakers to set more flexible exchange rate systems. This lowers, in turn, the likelihood of financial crises. More generally the framework of the paper can be used to shed new light on the recent world wide trend towards a bipolar system of exchange rate arrangements.

Suggested Citation

Cukierman, Alex and Goldstein, Itay and Spiegel, Yossi, The Choice of Exchange Rate Regime and Speculative Attacks (February 9, 2002). Available at SSRN: https://ssrn.com/abstract=301838 or http://dx.doi.org/10.2139/ssrn.301838

Alex Cukierman

Tel Aviv University - Eitan Berglas School of Economics ( email )

P.O. Box 39040
Ramat Aviv, Tel Aviv, 69978
Israel
+972 3 540 5360 (Phone)
+972 3 640 9908 (Fax)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

HOME PAGE: http://www.tau.ac.il/~alexcuk/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Itay Goldstein (Contact Author)

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Yossi Spiegel

Tel Aviv University, Coller School of Management ( email )

Ramat Aviv, Tel Aviv, 69978
Israel
972-3-640-9063 (Phone)
972-3-640-7739 (Fax)

HOME PAGE: http://www.tau.ac.il/~spiegel

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

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