Working Paper: NBER ID: w1437
Authors: Maurice Obstfeld
Abstract: This paper analyzes inevitable transitions between fixed and floating exchange-rate regimes in a balance-of-payments model where individual preferences are explicitly specified. The goal is to assessthe analogy between speculative attacks in foreign exchange markets and attacks on official price-fixing schemes in natural resource markets. In discrete time the analogy with resource markets is only partially correct, for in a deterministic model the collapse of a fixed rate may be characterized by two, successive attacks. The two-attack equilibriumis peculiar to discrete-time analysis, however. In the continuous-time limit of discrete-time models there is a single attack timed so as to rule out an anticipated discrete jump in the exchange rate.Balance-of-payments models differ from nonrenewable resource models in that foreign exchange reserves may be borrowed from abroad.The paper therefore asks whether there are limits to central-bank borrowing possibilities. In an idealized world where all private incomeis subject to lump-sum taxation, central-bank reserves can become infinitely negative with no violation of the public sector's intertemporal budget constraint. Nonetheless, a growth rate of domestic credit exceeding the world interest rate, if maintained indefinitely, leads to violation of the constraint in the paper's model.
Keywords: speculative attack; exchange rate regimes; central bank borrowing; balance of payments
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| excessive domestic credit expansion (E51) | collapse of fixed exchange rate (F31) |
| collapse of fixed exchange rate (F31) | speculative attack (D84) |
| shadow floating rate equals or exceeds fixed rate (E43) | speculative attack (D84) |
| excessive domestic credit growth (F65) | speculative attack (D84) |