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The Role of Public Information in a Contagious Currency Crisis

Economic Research Institute 2012.04.23 4198

This paper examines the effects of communication by the central bank on
the likelihood of the contagion of a currency crisis between two countries.
The quality of a central bank's communication strategy can influence
speculators' strategies, which is a mechanism by which the contagion of a
currency crisis from another country evolves either negatively or positively
(i.e., increases or reduces the probability of the country experiencing a
currency crisis). The result of the analysis of the threshold for a currency
crisis for each country indicate that an increase in communication (i.e.,
providing more public information) by the central bank can facilitate
positive contagion effects while reducing negative effects. Further, public
information provides a "focal point" for speculators and makes policy tools
more effective in promoting positive contagion effects. However, the
effectiveness of accurate public information depends critically on the ex
ante expected state of the economic fundamentals of the country.