TY - JOUR
T1 - Financial fragility and the exchange rate regime
AU - Chang, Roberto
AU - Velasco, Andrés
N1 - Funding Information:
1Velasco is grateful for support provided by the C.V. Starr Center for Applied Economics at NYU and the Harvard Institute for International Development. We are indebted to an anonymous referee for very useful comments. We also thank Guillermo Calvo, Rudi Dornbusch, Allan Drazen, Scott Freeman, Javier Hamann, Paul Krugman, Robert Lawrence, Leonardo Leiderman, Mancur Olson, Maurice Obstfeld, Arvind Panagariya, Carmen Reinhart, Will Roberds, Dani Rodrik, Jeffrey Sachs, Bruce Smith, Shang-jin Wei, Richard Zeckhauser, and participants at various seminars for numerous suggestions. Of course, any errors and ours alone. The views expressed here are ours and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.
PY - 2000/5
Y1 - 2000/5
N2 - We study financial fragility, exchange rate crises, and monetary policy in a model of an open economy with Diamond-Dybvig banks. The banking system, the exchange rate regime, and central bank credit policy are seen as parts of a mechanism intended to maximize social welfare; if the mechanism fails, banking crises and speculative attacks on the currency become possible. We compare currency boards, fixed rates, and flexible rates, with and without a lender of last resort. A currency board cannot implement a social optimum; in addition, it allows bank runs to occur. A fixed exchange rate system may implement the social optimum but is more prone to bank runs and exchange rate crises than a currency board. A flexible rate system implements the social optimum and eliminates runs, provided that the exchange rate and credit policies of the central bank are appropriately designed. Journal of Economic Literature Classification Numbers: F3, E5, G2.
AB - We study financial fragility, exchange rate crises, and monetary policy in a model of an open economy with Diamond-Dybvig banks. The banking system, the exchange rate regime, and central bank credit policy are seen as parts of a mechanism intended to maximize social welfare; if the mechanism fails, banking crises and speculative attacks on the currency become possible. We compare currency boards, fixed rates, and flexible rates, with and without a lender of last resort. A currency board cannot implement a social optimum; in addition, it allows bank runs to occur. A fixed exchange rate system may implement the social optimum but is more prone to bank runs and exchange rate crises than a currency board. A flexible rate system implements the social optimum and eliminates runs, provided that the exchange rate and credit policies of the central bank are appropriately designed. Journal of Economic Literature Classification Numbers: F3, E5, G2.
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U2 - 10.1006/jeth.1999.2621
DO - 10.1006/jeth.1999.2621
M3 - Article
AN - SCOPUS:0002405730
SN - 0022-0531
VL - 92
SP - 1
EP - 34
JO - Journal of Economic Theory
JF - Journal of Economic Theory
IS - 1
ER -