Currency Crises and Exchange Rate Instability

Abstract

Currency crises are usually modelled as an outgrowth of government policy imposed on an otherwise stable environment. This paper presents an alternative view in which government policy holds an economy in an unstable environment through controls on portfolio choice. As a result, the economies we model are subject to recurrent crises and the imposition of a bang-bang policy controls. This gives rise to a natural interpretation of pervasive exchange market intervention in small open economies.