A Model of a Double Standard Exchange Rate System

Riku Kinnunen ()
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Riku Kinnunen: University of Liverpool, Postal: Department of Economics and Accounting, The School of Management, University of Liverpool, Chatham Street, Liverpool, L69 7ZH, Great Britain

No 2003_05, Working Papers from University of Liverpool, Department of Economics

Abstract: In this paper I propose a "double standard" fixed exchange rate system which will be shown to have a higher expected lifetime than a conventional fixed exchange rate system. I present a simple variant of the classic Flood-Garber-Krugman model where the domestic currency is pegged to one of the two foreign currencies, depending on which exchange rate is lower; intuitively, this system thus corresponds to a gradual inflation stabilization program which will start at a future time that is determined by the foreign exchange market instead of the government. This type of a conditional peg implies that the domestic money holdings have a higher expected return as compared with the standard fixed exchange rate system. Since at each period there is a non-zero probability for the appreciation of the domestic currency, the demand for it is thus higher which decreases the probability of a speculative attack and increases the expected lifetime of the fixed exchange rate.

Keywords: speculative attacks; fixed exchange rates (search for similar items in EconPapers)
JEL-codes: E44 E58 F31 F43 (search for similar items in EconPapers)
Pages: 10 pages
Date: 2003-05-20
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Persistent link: https://EconPapers.repec.org/RePEc:liv:livedp:2003_05

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