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Handbook of Exchange Rates by Lucio Sarno, Ian Marsh, Jessica James

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25.3 Extensions

The KFG model stripped down both private and government behavior to bare essentials to provide sharp implications about the timing of speculative attacks. The model extensions have concentrated mainly on making government policy more realistic. We show below how such extensions can be accommodated in the KFG framework.

25.3.1 Attack-Conditional Monetary Policy

Flood and Garber (1984b) wrote a second paper using the Salant and Henderson framework. The second paper was about a speculative attack on a nominal gold-price-fixing scheme. The paper was motivated by discussions in Washington in the early 1980s, concerning the possible return to the gold standard.9 The theory was essentially the same as in S&H and in KFG, but there was an added twist. At the urging of Stephen Salant, Flood and Garber (1984b) added an attack-conditional post-attack monetary policy change. In terms of the KFG model, this amounts to having different rates of domestic-credit growth before, images, and after, images, the speculative attack with images.

Figure 25.4 shows how attack-conditional policy alters the model.

Figure 25.4 Attack states with attack-conditional policy shift.

This example of attack-conditional ...

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