Can International Currency Taxation Stabilise Currency Fluctuations?

Abstract

Developing countries are caught in a dilemma in terms of exchange rate policy. When macroeconomic policies are inconsistent with an exchange rate peg, and domestic prices and costs are sticky, real exchange rates will become misaligned, allowing currencies to be vulnerable to speculative attacks. However, eradicating misalignments by devaluation can itself create problems. Not only are there political constraints, as devaluation is seen as a badge of failure, but also devaluation can spark off an inflationary impulse as well as cause additional speculation that pushes the currency into free fall. It may then prove difficult to engineer a “soft landing”.¹