The Choice of Exchange Rate Regime and Speculative Attacks

Alex Cukierman, Yossi Spiegel and Itay Goldstein

No 3714, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 framework makes it possible to study, for the first time, the strategic interaction between the ex ante choice of regime and the probability of ex post currency 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. Our framework generates several novel predictions and shows that when the endogeneity of the exchange rate regime is recognized explicitly, conventional wisdom may be reversed. For instance, the imposition of a Tobin tax, by inducing policymakers to set less flexible regimes, may raise the likelihood of speculative attacks.

Keywords: Currency crises; Choice of exchange rate regime; Speculators; Tobin tax; Global games; Reputation (search for similar items in EconPapers)
JEL-codes: F30 F40 (search for similar items in EconPapers)
Date: 2003-01
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (2)

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