Working Paper

The business cycles of currency speculation: a revision of the Mundellian framework

Abstract: In his seminal 1960 study on the dynamics of alternative exchange rate regimes, Robert Mundell proposed a theory of balance-of-payments crises in which speculators base their actions on the observed holdings of central bank foreign reserves. We examine the quantitative implications of this view from the perspective of an equilibrium business cycle model in which rational expectations of a devaluation are conditioned on foreign reserves. The model explains some of the empirical regularities of the business cycle associated with temporary fixed-exchange-rate regimes. In turn, these cyclical dynamics validate the agents' expectations by producing devaluation probabilities that resemble those estimated from the data. The model thus aims to explain both the real effects and the collapse of exchange-rate-based stabilizations in a unified framework.

Keywords: Business cycles; Money; Econometric models;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 1998

Number: 617