Consider two identical countries in our standard overlapping generations model. In each country, the population of every generation is 100, and each young person wants money balances worth 10 goods. There are $400 of country a money and £100 of country b money. The exchange rate is fixed at 1. There are no foreign-currency controls, and the monetary authorities do not cooperate. Each country is willing to raise up to 500 goods in taxes on their old citizens to defend the exchange rate.

a. What is the value in goods of a dollar? Of a pound?

b. Find the value of a dollar if people abandon use of the pound and the value of a pound if people abandon use of a dollar.

c. To be free from a speculative attack, a country’s commitment to defend the exchange rate must be sufficient to purchase all of its currency if it is offered for foreign exchange. Which of these two countries is subject to a speculative attack? (Hint: In answering, you will need to use your answers to part

b, not to part a.)