url
31
Aug
2014

ASIAN CURRENCY CRISIS: Results


At time T, the new monetary policy is implemented so that there is a policy induced jump in MT after which the money supply grows at rate //. The government engineers the increase in Mt by retiring government debt. Before the new transfer policy is implemented at T’ the government is actually running a surplus, so that government debt is declining. After T’ (not displayed) both the government deficit and the debt begin to increase other.

Why Doesn’t the Attack Take Place At Time Zero?

A fixed exchange rate regime is a price fixing scheme. As long as the government can borrow enough funds it can support a fixed price for its currency. So the key determinants of t* are the government’s ability to borrow, which is determined by its intertemporal budget constraint, its willingness to borrow, which is determined by Ф, and agent’s demand for domestic money. The latter demand is tied to agents’ optimal consumption path. For a speculative attack to occur at time 0 there must be a large enough drop in c0 to trigger the threshold rule on debt. Since the new monetary policy is only implemented at T, and inflation at time 0 is actually low relative to later periods, consumption does not typically drop at t = 0. As noted above in the benchmark model it actually rises.

To provide further intuition about the relation between consumption and exchange rate dynamics, Figure 2 depicts the equilibrium of the model if the government maintains its choice of T, Mt and /i but abandons fixed exchange rates at time 0 while keeping the money supply at some value Mq until time T. Figure 2 corresponds to the case where Mq = M.

The key feature to note is that here the exchange rate initially appreciates at t = 0. This is because inflation is lower at time zero than in later time periods. Since the effective price of consumption is low relative to future periods, the initial level of consumption rises relative to the old steady state. Since the money supply is constant, the cash in advance constraint implies that S must fall, i.e. the exchange rate appreciates. This illustrates the importance of the link between consumption and money demand in determining exchange rate dynamics. An attack will happen at time 0 only if consumption and real balances fall enough to drive government debt to a value greater than or equal to Ф.

Sensitivity Analysis

Table 2 describes the effect of perturbations to the Korean benchmark parameter values on the timing of a speculative attack and the present value of seignorage revenues. Four key results emerge here. First, if the increase in the deficit reflects a rise in government purchases rather than an increase in transfers, then t* falls.

At time T, the new monetary policy is implemented so that there is a policy induced jump in MT after which the money supply grows at rate //. The government engineers the increase in Mt by retiring government debt. Before the new transfer policy is implemented at T’ the government is actually running a surplus, so that government debt is declining. After T’ (not displayed) both the government deficit and the debt begin to increase other. Why Doesn’t the Attack Take Place At Time Zero? A fixed exchange rate regime is a price fixing scheme. As long as the government can borrow enough funds it can support a fixed price for its currency. So the key determinants of t* are

About The Author

Kevin J. Brandon

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