Currency Crises and Foreign Reserves: A Simple Model

Piti Disyatat

No 2001/018, IMF Working Papers from International Monetary Fund

Abstract: This paper addresses the important question of how far a government will run down its stock of foreign reserves in a defense of a fixed exchange rate. An optimizing model of currency crisis is presented in which the decision of whether or not to borrow in a defense of a peg is explicitly analyzed. The threshold level of reserves is then determined endogenously and shown to be a function of fundamental economic variables. The analysis also demonstrates how an increase in the level of reserves, a credit-rating upgrade, or the imposition of capital controls can remove the multiplicity of equilibria.

Keywords: WP; rate of depreciation; Currency Crisis; Speculative Attacks; Borrowing Reserves; open economy; peg hinge; currency defense; nominal exchange rate; depreciation expectation; currency parity; government indifference boundary; capital control; Depreciation; Currencies; Conventional peg; International reserves; Reserve positions (search for similar items in EconPapers)
Pages: 24
Date: 2001-02-01
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Citations: View citations in EconPapers (11)

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