Importing credibility through exchange rate pegging

Research output: Contribution to journalArticle

11 Scopus citations

Abstract

This paper employs an optimal taxation framework in order to study the credibility of monetary policy-making in an open economy. Since inflation is, in part, uncontrollable due to stochastic disturbances, the authority's actions cannot be monitored perfectly when the exchange rate floats, thus implying that reputational forces may become ineffective. In contrast, pegging the nominal exchange rate to a low-inflation currency allows perfect monitoring, because the exchange rate is, in principle, controllable. For this reason, exchange rate pegging may import credibility and result in the best reputational equilibrium, even though the authority retains the discretion to devalue unexpectedly.

Original languageEnglish (US)
Pages (from-to)687-694
Number of pages8
JournalEconomic Journal
Volume107
Issue number442
DOIs
StatePublished - May 1997
Externally publishedYes

ASJC Scopus subject areas

  • Economics and Econometrics

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