The Dynamics of Currency Crises---Results from Intertemporal Optimization and Viscosity Solutions

Christian Bauer and Philip Ernstberger

No 2014-06, Research Papers in Economics from University of Trier, Department of Economics

Abstract: We apply an infinite horizon intertemporal optimization model to a simple speculative attack framework. Thereby, the central bank faces a one control two-state variables optimization problem with endogenuous exit. By setting the interest rate the central bank can stimulate the economy or fend off speculators. We show that two focal points emerge. Depending on the time preference and the state, cycles can improve utility. A regime change is associated with costs and can be forced by the state of the economy or induced by choice. In the latter case the costs for defending outweigh the costs of an immediate opt-out. During the existence of the regime the highest growth is reached through convergence to a no stress steady state, but is only optimal for a central bank with low time preference. Therefore, we propose to take measures assuring a lower time preference like independence, long-term mandates, and long-term policy goals.

Keywords: intertemporal optimization; currency crises; policy design (search for similar items in EconPapers)
JEL-codes: C61 E58 E61 F3 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2014
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:trr:wpaper:201406

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