Endogenous reserves and the collapse of the exchange rate mechanism: a stochastic analysis

摘要

This work develops an alternative interpretation of the Exchange Rate Mechanism (ERM) Crises occurred in 1992. The model outlined in the paper assumes that the endogeneity of the reserves with respect to the deviation of the normal exchange from the central parity exacerbates the size of the speculative attack. By considering a continuos-time stochastic velocity shock in the demand for money equation, it is possible to take into account the feedback effects from the exchange rate to the fundamental in the resulting model with saddle path dynamics. The main result in presence of an irreversible switch of regime is that the size of the attack is amplified. The issue of sustainability of the target zone increases as a time-varying realignment probability is considered in the basic stochastic system.