TY  - JOUR
AU  - Chang, Roberto
AU  - Velasco, Andres
TI  - Financial Fragility and the Exchange Rate Regime
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6469
PY  - 1998
Y2  - March 1998
DO  - 10.3386/w6469
UR  - http://www.nber.org/papers/w6469
L1  - http://www.nber.org/papers/w6469.pdf
N1  - Author contact info:
Roberto Chang
Rutgers University
Department of Economics
75 Hamilton Street
New Brunswick, NJ  08901
Tel: 732/932-7269
Fax: 732/932-7416
E-Mail: chang@econ.rutgers.edu

Andrés Velasco
Columbia University
School of International and Public Affairs
420 West 118th Street
New York, NY 10027
Tel: 212/854-3899
E-Mail: avbranes@gmail.com
AB  - We study financial fragility, exchange rate crises and monetary policy in an open economy model in which banks are maturity transformers as in Diamond-Dybvig.  The banking system, the exchange rate regime, and central bank credit policy are seen as parts of a mechanism intended to maximize social welfare; if the mechanism fails, banking crises and speculative attacks become possible.  We compare currency boards, fixed rate and flexible rates, with and without a lender of last resort.  A currency board cannot implement a socially optimal allocation; in addition, under a currency board bank runs are possible.  A fixed exchange rate system may implement the social optimum but is more prone to bank runs and exchange rate crises than a currency board.  Larger capital inflows enhance welfare if the no-run equilibrium occurs, but may also render the economy more vulnerable to self-fulfilling runs.  A flexible exchange rate system implements the social optimum and eliminates runs, provided the exchange rate and central bank lending policies of the central bank are appropriately designed.
ER  -