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Financial fragility and the exchange rate regime

Author

Listed:
  • Roberto Chang
  • Andres Velasco
Abstract
We study financial fragility, exchange rate crises, and monetary policy in an open economy version of a Diamond-Dybvig model. 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 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 socially optimal allocation; in addition, bank runs are possible under a currency board. 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 the exchange rate and central bank lending policies are appropriately designed.

Suggested Citation

  • Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," FRB Atlanta Working Paper 97-16, Federal Reserve Bank of Atlanta.
    • Handle: RePEc:fip:fedawp:97-16
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    References listed on IDEAS

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    More about this item

    Keywords

    Banks and banking; Central; Financial crises; Financial institutions; Foreign exchange rates;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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