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2
Sep
2014

ASIAN CURRENCY CRISIS: Results 2

The reason for this is as follows. In the benchmark model, time 0 consumption rises by 2 percent relative to its initial steady state level. Correspondingly, there is an increase in the demand for money and a reduction in the government’s debt. Other things equal, the reduction in b0 — f0 delays the time at which bt — ft reaches its threshold level, Ф. Because of the rise in future government purchases, the household’s wealth declines relative to its initial steady state value.

Consequently time 0 consumption does not rise by as much as in the benchmark model. Now с is roughly equal to the initial steady state level of consumption, c, and there is no initial improvement in the government’s debt position. Other things equal, this implies bt — ft will reach Ф more quickly than in the benchmark case. Note that seignorage revenues also fall relative to the benchmark case. This occurs primarily because the fall in the household’s wealth leads to a decline in с which reduces the flow of seignorage revenues (цс) after T.
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Second, a decrease in the elasticity of intertemporal substitution to 1/5 (cr = 5) increases t*. This reflects a greater desire on the part of the household to have a smooth consumption path. There is also a small decline in seignorage revenues which results from a lower level of c. Third, a rise in T increases t* and reduces the present value of seignorage revenues. The latter happens because positive seignorage revenues are generated only when the new monetary policy is implemented. Fourth, an increase in Ф increases t* and reduces the present value of seignorage revenues.

The basic reason for the rise in t* is that it takes longer for government debt to hit the threshold level associated with abandoning fixed exchange rates. The impact on seignorage revenues is more subtle. Recall that no seignorage revenues are collected between t* and T, i.e. /fT e~rt(mt + 7rtmt)dt = 0, so that the increase in t* has no direct impact on the present value of seignorage revenues. As it turns out, the decline in seignorage is caused by the fall in money demand, M — M*, that occurs when the government debt jumps to its threshold level Ф at t*. The higher is Ф. the larger is the decline in money demand and the greater is the loss in seignorage revenue at t*.

A potential shortcoming of the experiments reported in Table 2 is that they do not hold seignorage revenues constant. We now consider the results of experiments in which monetary policy is adjusted to ensure that the government’s intertemporal budget constraint is satisfied. Table 3 reports results when monetary policy is adjusted via changes in Mt, while Table 4 corresponds to the case in which fi is adjusted.

Consider first the results of perturbing the benchmark values of a and T, as well as assuming that the rise in prospective deficits reflects a rise in future government purchases. Comparing Tables 2, 3 and 4 we see that very small adjustments in monetary policy are necessary to compensate for the changes in seignorage revenues associated with these perturbations of the benchmark model. As a consequence the analogue values of t* in the three tables are very similar.

The reason for this is as follows. In the benchmark model, time 0 consumption rises by 2 percent relative to its initial steady state level. Correspondingly, there is an increase in the demand for money and a reduction in the government’s debt. Other things equal, the reduction in b0 — f0 delays the time at which bt — ft reaches its threshold level, Ф. Because of the rise in future government purchases, the household’s wealth declines relative to its initial steady state value. Consequently time 0 consumption does not rise by as much as in the benchmark model. Now с is roughly equal to the initial steady state level of consumption, c, and there is no initial improvement in the

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Kevin J. Brandon

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