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Financial Fragility, Exchange-Rate Regimes, and Sudden Stops in a Small Open Economy

Grace Wang, Paula Hernandez-Verme () and Raymond Cox

Ekonomi-tek - International Economics Journal, 2012, vol. 1, issue 3, 25-54

Abstract: We model a typical Asian economy in crisis using a dynamic general equilibrium technique and establishing exchange rates from nontrivial fiatcurrency demands. Sudden stops/bank panics are possible and are essential for evaluating the merits of alternative exchange-rate regimes. Strategic complementarities contribute to the severe indeterminacy of a continuum of equilibria. Social welfare and the scope of equilibria are also associated with the underlying policy regime and the built-in Sequential Checking Mechanism, including liquidity, solvency, and incentive-compatibility constraints in the model. Combining domestic and foreign reserve requirements promotes stability under a floating exchange-rate regime; however, this increases the scope for panic equilibria under both floating and fixed regimes. While backing the money supply reduces financial fragility under both systems, it only acts as a stabilizer in a fixed regime.

Keywords: Sudden stops; exchange-rate regimes; multiple reserve requirements (search for similar items in EconPapers)
JEL-codes: E31 E44 F41 (search for similar items in EconPapers)
Date: 2012
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