When pegging ties your hands

Could a less conservative central bank - one that faces a more severe time inconsistency problem - be less likely to succumb to an attack on a currency peg? Traditional currency-crisis models provide a firm answer: No. We argue that the answer stems from these models' narrow focus on how a central bank's response to a speculative attack affects output and inflation in the short run. The answer may reverse if we recognize that a credible currency peg solves time consistency issues in the long run. As a less conservative central bank stands to benefit more from tying its own hands, it should find a peg more valuable.

JEL classification: D82, D84, F31

Keywords: currency crises, strategic uncertainty, global games, time inconsistency

The views expressed in this publication are those of the authors and do not necessarily reflect the views of the BIS or its member central banks.