291
See also: Economic bubbles 98–99 ■ Rational expectations 244–47 ■ Exchange rates and currencies 250–55 ■
Financial crises 296–301 ■ Bank runs 316–21 ■ Global savings imbalances 322–25
CONTEMPORARY ECONOMICS
Women examine a new Zimbabwean
dollar bank note in 2009. After a period
of hyperinflation, the government
revalued the currency by removing
12 zeroes from the old notes.it is assumed that people can see
that eventually the foreign currency
reserves of the central bank will be
exhausted. The exchange rate will
then have to “float” (be traded
freely) and decline. The model
proposes that there is a “shadow
exchange rate,” which is what
the exchange rate would be if the
central bank were not defending
the fixed exchange rate. People
know what this shadow exchange
rate is (and will be) at any given
time by looking at the government
deficit. The moment they see that it
is better to sell the home currency
... a speculative attack on the currency
may be launched.Beliefs can trigger
currency crises.... government policies
are inconsistent with
a fixed exchange rate
and there is an opportunity
to make a profit...... an exchange rate
is vulnerable due
to weak banks, a financial
bubble, misinformation,
or the actions of other
speculators...... government’s
commitment to an
exchange rate is
constrained by conflicting
domestic priorities...If people believe that...at the fixed exchange rate than at
the shadow exchange rate, they
will launch a speculative attack
and buy all the foreign currency
reserves at the central bank. The
home currency will then be forced
to float, and the depreciating
shadow exchange rate will become
the actual exchange rate. The
speculative attack occurs at
the point where the steadily
depreciating shadow exchange
rate equals the fixed exchange rate.
This model seemed relevant
to the currency crises in Latin
America in the 1970s and 1980s, ❯❯