The Choice of Exchange-Rate Regime and Speculative Attacks

Alex Cukierman, Itay Goldstein and Yossi Spiegel
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Itay Goldstein: Wharton School, University of Pennsylvania,
Yossi Spiegel: Tel Aviv University,

Journal of the European Economic Association, 2004, vol. 2, issue 6, 1206-1241

Abstract: We develop a framework that makes it possible to study, for the first time, the strategic interac-tion between the ex ante choice of exchange-rate regime and the likelihood of ex post currency attacks. The optimal regime is determined by a policymaker who trades off the loss from nom-inal exchange-rate uncertainty against the cost of adopting a given regime. This cost increases, in turn, with the fraction of speculators who attack the local currency. Searching for the optimal regime within the class of exchange-rate bands, we show that the optimal regime can be either a peg (a zero-width band), a free float (an infinite-width band), or a nondegenerate band of finite width. We study the effect of several factors on the optimal regime and on the probability of currency attacks. In particular, we show that a Tobin tax induces policymakers to set less flexible regimes. In our model, this generates an increase in the probability of currency attacks. (JEL: F31, D84) Copyright (c) 2004 by the European Economic Association.

Date: 2004
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