Chapter

Crises and Policy Imbalances

Giovanni Piersanti

in The Macroeconomic Theory of Exchange Rate Crises

Published in print April 2012 | ISBN: 9780199653126
Published online September 2012 | e-ISBN: 9780191741210 | DOI: http://dx.doi.org/10.1093/acprof:oso/9780199653126.003.0003
Crises and Policy Imbalances

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This chapter discusses the basic analytical framework of “first-generation” models of currency crises and their extensions to deal with important features of balance-of-payments crises such as alternative post-collapse regimes, capital control and borrowing constraints, interest rate defence policies, the interaction between bank solvency and currency stability, uncertainty about government policies, real effects of crises. The key implication of this approach is that a fixed exchange rate regime cannot survive the long-run inconsistency between monetary, fiscal, and exchange rate policies. Unnecessary domestic money growth leads to a persistent loss of reserves and ultimately to a speculative attack against the home currency that forces the government to switch out of the peg once reserves approach a minimum level. It also predicts that the attack will take place at the point where the shadow exchange rate (i.e., the rate that would prevail if the government diverted into a floating rate) equals the fixed peg.

Keywords: fixed exchange rate regime; shadow exchange rate; money growth; budget deficits; speculative attacks; timing of attacks; balance-of-payments crises; twin crises

Chapter.  33987 words.  Illustrated.

Subjects: Macroeconomics and Monetary Economics

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