Currency Crises and Foreign Reserves: A Simple Model
24 Pages Posted: 31 Jan 2006
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Currency Crises and Foreign Reserves: A Simple Model
Currency Crises and Foreign Reserves: A Simple Model
Date Written: February 2001
Abstract
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.
Keywords: Currency Crisis, Speculative Attacks, Borrowing Reserves
JEL Classification: E50, F30, F32, F32
Suggested Citation: Suggested Citation
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