AModelofCommitmentStrengtheninginaFixedExchange.pptVIP

A Model of Commitment Strengthening in a Fixed Exchange Rate Regime Y. Stephen Chiu HKIMR and CUHK August 2001 Introduction Currency attacks may arise from neither bad fundamentals nor irresponsible domestic policies, but simply from a time consistency problem The time consistency problem--Ex ante, the government prefers to keep the peg. But upon a large scale attack, it prefers to abandon the peg. One remedy is to increase the devaluation cost the government incurs should the latter scenario arises. This mitigates the time consistency problem, and speculators will become less aggressive. Ba