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External Shocks, Balance Sheet Contagion, and Speculative Attack on the Pegged Exchange Rate System
Author(s) -
Ma Yue
Publication year - 2009
Publication title -
review of development economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.531
H-Index - 50
eISSN - 1467-9361
pISSN - 1363-6669
DOI - 10.1111/j.1467-9361.2008.00464.x
Subject(s) - economics , monetary economics , shock (circulatory) , capital control , exchange rate , balance sheet , capital outflow , current account , capital (architecture) , currency , capital flows , currency crisis , asset (computer security) , exchange rate regime , capital account , capital formation , financial capital , market economy , liberalization , finance , medicine , computer security , archaeology , computer science , history , human capital
A simple monetary model is built to illustrate that the pegged exchange rate system will collapse under an unstable external environment via the balance sheet contagion and the “boiling frog” effect, even if the domestic policy and the fundamentals are sound. If agents anticipate this happening, a speculative attack may still occur. This result is different from that of the first‐generation currency crisis model, where the inconsistent domestic policy brings in the collapse of the peg. The policy options to defend the peg in the author's model depend on the nature of the shock. Effective capital control can only be implemented for capital outflow shock. Capital account deregulation is more stabilizing under a current account deficit shock, however. This paper also distinguishes the effect of capital mobility with that of the asset substitutability, as they have completely different impacts on the peg.