We applied an infinite horizon intertemporal optimization model with endogenous exit to a simple speculative attack framework. The central bank sets the interest rate which influences both fundamentals and attack strength. Hence, with one variable the central bank improves fundamentals but also increases stress. The central bank’s role is beyond solely responding to speculative pressure or signaling. Depending on the current state the decision of the central bank has different implications for its own future position. Consequently, the central bank has to weigh the different outcomes against each other. If there is no dominant path, the optimal policy depends on the time preference of the central bank.
KeywordsInterest Rate Focal Point Central Bank Time Preference Regime Switch
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