Optimal Transparency and Risk-Taking to Avoid Currency Crises

This paper reconsiders a central bank's problem of determining rules for information dissemination and risk-taking behavior that minimize the probability of currency crises. In a global-games approach, we find that optimal transparency is adversely related to prior market beliefs. In countries with pessimistic prior beliefs about economic performance, the central bank should commit to disclosing information with maximal precision. In addition, it should increase the risk of economic performance. For good prior expectations, posterior information should be of lower precision, depending on the variance of fundamentals. Here, the central bank can reduce the crisis probability by reducing that variance.