Do central banks cause attacks on their currency?

My last post looked at the game theory of exchange rate attacks. They are a co-ordination game where if enough traders believe that an attack will be successful then it probably will be. This leads to the question of whether central banks can actually encourage attacks on their currency by making public statements. If the public statement makes a trader think that the currency is weak then they will know that others think the same thing and that will make a co-ordinated attack more likely.

As well as the public information that is available from the central bank each trader will have their own sources of private information which will influence their decisions.

If the central bank gives out too much public information then it is more likely that the traders will be confident of a co-ordinated attack on the currency. Private information gives different signals to different traders and so makes it more uncertain for them and so they are less likely to be confident of co-ordinating an attack. They don’t want to be the only one to go for an attack or they will lose out.

This is an example of a wider point which is that in any game it is likely that different players are relying on different sources of information. When they are playing a game that requires co-ordination then the more different sources of information they are using the more likely it is that they will not be able to co-ordinate.

If you are trying to co-ordinate actions with other then this will be easier if you can minimise the sources of information that everyone has access to and if you can increase the credibility of one particular source so that everyone will act based on that source.

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