Working Paper: CEPR ID: DP7651
Authors: Itay Goldstein; Emre Ozdenoren; Kathy Yuan
Abstract: We study a model where the aggregate trading of currency speculators reveals new information to the central bank and affects its policy decision. We show that the learning process gives rise to coordination motives among speculators leading to large currency attacks and introducing non-fundamental volatility into exchange rates and policy decisions. We show that the central bank can improve the ex-ante effectiveness of its policy by committing to put a lower weight ex-post on the information from the market, and that transparency may either increase or decrease the effectiveness of learning from the market, depending on how it is implemented.
Keywords: coordination; currency attacks; feedback effects; financial markets; global games; heterogeneous information; strategic complementarities
JEL Codes: C7; F31; G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central bank's learning from speculative trading (E58) | Coordination motives among speculators (D84) |
| Coordination motives among speculators (D84) | Large currency attacks (F31) |
| Large currency attacks (F31) | Central bank's belief in weak economic fundamentals (E58) |
| Central bank's belief in weak economic fundamentals (E58) | Regime change (P39) |
| Central bank's commitment to lower weight on market information (E58) | Altered speculator incentives (G19) |
| Altered speculator incentives (G19) | More informative attacks (Y50) |
| Transparency (G38) | Effectiveness of learning (J24) |