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Gains from Commitment: The Case for Pegging the Exchange Rate

Author

Listed:
  • Kai Arvai
  • Ricardo Duque Gabriel

Abstract

This paper argues that the exchange rate regime matters for inflation and economic activity, with substantial benefits arising from a currency peg. At the heart of these benefits lies an increase in credibility that reduces the inflationary bias once central banks commit to peg their currency to a credible anchor. Using an open economy model, we provide a credibility estimate for 170 economies for 1950-2019 which aligns with other central bank independence measures. We document that committing to a peg persistently lowers inflation and its volatility while increasing real economic growth. Less credible countries benefit more from fixing the exchange rate.

Suggested Citation

  • Kai Arvai & Ricardo Duque Gabriel, 2024. "Gains from Commitment: The Case for Pegging the Exchange Rate," Working papers 974, Banque de France.
    • Handle: RePEc:bfr:banfra:974
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    File URL: https://www.banque-france.fr/system/files/2024-12/WP974_0.pdf
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    More about this item

    Keywords

    Exchange Rate Regimes; Monetary Policy; Interest Rates; Inflation;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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