There are two actors: the central bank and speculators. The central bank maximizes utility where instantaneous utility u is derived from the state of the fundamentals θ (t) and is discounted by factor ρ. The initial values of the fundamentals and the attack are θS = θ (0) and AS = A(0). The overall utility U is the sum of the aggregated discounted instantaneous utility up to terminal time T plus the discounted terminal value.1 The terminal time denotes the time when the central bank is forced to devalue and is endogenously determined by the state processes. The terminal value υ is a function of the fundamentals at terminal time less an amount c representing the costs of the regime change. For the remainder of the paper, we assume that the proceeding regime is in a steady state, so that the terminal value υ is constant.
KeywordsInterest Rate Central Bank Time Preference Extend Linear Bellman Equation
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