Financial fragility and the exchange rate regime

Roberto Chang, Andrés Velasco

Research output: Contribution to journalArticle

99 Citations (Scopus)

Abstract

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.

Original languageEnglish (US)
Pages (from-to)1-34
Number of pages34
JournalJournal of Economic Theory
Volume92
Issue number1
DOIs
StatePublished - May 2000

Fingerprint

Currency board
Social optimum
Financial fragility
Exchange rate regimes
Credit policy
Exchange rate crises
Central bank
Bank runs
Exchange rate policy
Open economy
Social welfare
Economics
Bank credit
Banking system
Currency
Fixed exchange rates
Banking crisis
Monetary policy
Lender of last resort
Diamond

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Cite this

Chang, Roberto ; Velasco, Andrés. / Financial fragility and the exchange rate regime. In: Journal of Economic Theory. 2000 ; Vol. 92, No. 1. pp. 1-34.
@article{d1f09603837f4561ab26825ed6823f13,
title = "Financial fragility and the exchange rate regime",
abstract = "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.",
author = "Roberto Chang and Andr{\'e}s Velasco",
year = "2000",
month = "5",
doi = "https://doi.org/10.1006/jeth.1999.2621",
language = "English (US)",
volume = "92",
pages = "1--34",
journal = "Journal of Economic Theory",
issn = "0022-0531",
publisher = "Academic Press Inc.",
number = "1",

}

Financial fragility and the exchange rate regime. / Chang, Roberto; Velasco, Andrés.

In: Journal of Economic Theory, Vol. 92, No. 1, 05.2000, p. 1-34.

Research output: Contribution to journalArticle

TY - JOUR

T1 - Financial fragility and the exchange rate regime

AU - Chang, Roberto

AU - Velasco, Andrés

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.

UR - http://www.scopus.com/inward/record.url?scp=0002405730&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=0002405730&partnerID=8YFLogxK

U2 - https://doi.org/10.1006/jeth.1999.2621

DO - https://doi.org/10.1006/jeth.1999.2621

M3 - Article

VL - 92

SP - 1

EP - 34

JO - Journal of Economic Theory

JF - Journal of Economic Theory

SN - 0022-0531

IS - 1

ER -