Financial Liberalization and the Stability of Currency Pegs

38 Pages Posted: 10 Feb 2004

Multiple version iconThere are 2 versions of this paper

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

Bhattacharya, Utpal, Financial Liberalization and the Stability of Currency Pegs (October 2003). Available at SSRN: https://ssrn.com/abstract=198809 or http://dx.doi.org/10.2139/ssrn.198809

Utpal Bhattacharya (Contact Author)

HKUST Business School ( email )

Clear Water Bay
Kowloon
Hong Kong

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