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A Theory of Currency Board with Irrevocable Commitments *
Author(s) -
Chan Alex W. H.,
Chen Naifu
Publication year - 2003
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2005.00045.x
Subject(s) - currency , currency board , government (linguistics) , economics , convertible , foreign exchange reserves , construct (python library) , monetary economics , exchange rate , money supply , reserve currency , simple (philosophy) , business , foreign exchange risk , monetary policy , computer science , engineering , linguistics , philosophy , structural engineering , programming language , epistemology
Abstract Currency boards are subject to runs if the foreign currency reserve is insufficient to back the convertible money supply. We construct a simple model and show how pre‐specified optimal reserve commitments can avert currency board runs. If there exists asymmetric information on the government's resolve, the government can also use commitments as a costly signal to induce a separating equilibrium. The model can be adapted to analyze other hard‐fixed exchange rate systems such as dollarizations and monetary unions. We illustrate the implications of our model in terms of the recent success in Hong Kong and possible remedies for Argentina.