A continuous time dynamic model for the analysis of currency board fragility

In this research, we study a two-dimensional dynamical system for a currency board, where the evolution of domestic liquidity is strictly related to the dynamics of foreign reserves. We employ a nonlinear continuous-time model which delivers more precise coefficients in terms of both efficiency of estima-tions and speed of convergence. The Gaussian errors produced by the integrations performed deliver small standard errors and precise forecasting and simulations. Using the model estimates, we run simulations that are able to replicate the neg-ative feedback-loop between domestic liquidity and the state of confidence in Argentina, that called for liquidity injections to contrast the exhaustion of foreign reserves. Our findings can help shape the discussion on the viability of a currency-board regime, highlighting that it cannot substitute for structural competitiveness or external balance. Our analysis can provide insights on the constraints for a currency zone where economies abandon their monetary policy.