Financial Liberalization and the Stability of Currency Pegs
38 Pages Posted: 10 Feb 2004
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Financial Liberalization and the Stability of Currency Pegs
Date Written: October 2003
Abstract
This paper analyzes how the strategies of domestic firms borrowing abroad complicate the interaction between central banks and foreign exchange speculators. If we define financial liberalization as the degree of freedom given to domestic firms to borrow abroad, we find that in the early stages of financial liberalization, foreign borrowing does not affect the stability of the currency peg, but in the advanced stages of financial liberalization, foreign borrowing destabilizes currency pegs. When this happens, we show that policies to curb currency speculators have no effect. The paper thus formalizes the critical juncture where financial liberalization and currency pegs become incompatible policy goals.
Keywords: Corporate borrowing, currency speculators, central bank intervention, exchange rate pegs
JEL Classification: G15, F31, F34, D84
Suggested Citation: Suggested Citation
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