Anomalous Speculative Attacks On Fixed Exchange Rate Regimes Possible Resolutions Of The "Gold Standard Paradox"

This paper analyzed Krugman's contention that there is a "gold standard paradox" in the speculative attack literature. The paradox occurs if when a country runs out of gold its currency appreciates or, equivalently, if a speculative attack happens only after the country would have run out of reserves in the absence of a speculative attack. We first show that this "gold standard paradox is a very general phenomenon", relevant for all price fixing or price stabilisation schemes, which does not require mean reverting processes for the fundamentals and which can be present in discrete time models as well as in continuous time models. Next we show that the explicit consideration of the presence ans role of international currency arbitrageurs is one way of eliminating the paradox. If a "natural collapse" appears to occur before a speculative collapse, arbitrageurs keep official reserves just above the critical threshold level until the speculative attack point is reached. When the speculative attack occurs, official reserves do not undergo any finite change. The increased non-arbitrage demand for the currency of the country that abandons the gold standard is met out of the accumulated currency holdings of private arbitrageurs.(This abstract was borrowed from another version of this item.)