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Preventing Currency Crises in Emerging Markets$
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Sebastian Edwards and Jeffrey A. Frankel

Print publication date: 2002

Print ISBN-13: 9780226184944

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226185057.001.0001

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Living with the Fear of Floating

Living with the Fear of Floating

An Optimal Policy Perspective

(p.663) 14 Living with the Fear of Floating
Preventing Currency Crises in Emerging Markets
Amartya Lahiri, Carlos A. Végh
University of Chicago Press

This chapter describes the policies aimed at defending a currency under attack. It utilizes a theoretical model to compute the monetary authorities' optimal reaction to a demand for money shock. It is noted that the nominal wage rises by the same proportion as the exchange rate. For the purposes of insulating the real side of the economy from real shocks, flexible exchange rates are better than fixed exchange rates. The existence of nominal wage rigidities is important in generating the result that the nominal exchange rate should be kept fixed. The developed theoretical model predicts a nonmonotonic relationship between the nominal exchange rate and the size of the shock. Furthermore, it is believed that the “fully sterilized intervention” policy presented is one that always keeps the real quantity of money constant, which appears appropriate in general.

Keywords:   currency, money shock, nominal wage, exchange rates, theoretical model, fully sterilized intervention, policies

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