A Theory of Fear of Floating

Javier Bianchi and Louphou Coulibaly

No 796, Working Papers from Federal Reserve Bank of Minneapolis

Abstract: Many central banks whose exchange rate regimes are classified as flexible are reluctant to let the exchange rate fluctuate. This phenomenon is known as “fear of floating”. We present a simple theory in which fear of floating emerges as an optimal policy outcome. The key feature of the model is an occasionally binding borrowing constraint linked to the exchange rate that introduces a feedback loop between aggregate demand and credit conditions. Contrary to the Mundellian paradigm, we show that a depreciation can be contractionary, and letting the exchange rate float can expose the economy to self-fulfilling crises.

Keywords: Self-fulfilling financial crises; Exchange rates (search for similar items in EconPapers)
JEL-codes: E44 E52 F33 F34 F36 F41 F45 G01 (search for similar items in EconPapers)
Date: 2023-02-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
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Citations: View citations in EconPapers (4)

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Working Paper: A Theory of Fear of Floating (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmwp:95598

DOI: 10.21034/wp.796

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