Credibility of the Exchange Rate Policy in Transition Countries

Credibility of an exchange rate policy is one of the most important factors contributing to success or failure of any stabilization program. Authorities usually hope that the public will trust official exchange rate commitments and take decisions regarding domestic currency holdings accordingly. However, as the experience of several countries analyzed in this study shows, this is not always the case. Economic agents behave in line with their own expectations which need not directly reflect central bank's commitments but are most often a combination of official policy and public's own notions regarding its actual future course. There are clear advantages of high credibility of exchange rate policy to the country's disinflation efforts. It can help bring inflation down quicker and reduce inevitable output losses. Naturally, this prompts the question of whether one can quantify credibility and find factors that are affecting it. Various studies found in the literature have attempted to find an answer to this problem. In line with these efforts, our paper tries to shed new light on the issue. It makes use of the new theoretical model specially designed to approximate credibility of exchange rate policy and provides its empirical application for a number of transition economies that have actively used exchange rate policy in their stabilization programs during the 1990s. For each country we present the modelderived coefficient of credibility, draw conclusions from the model's predictions and confront it with the behavior of other macroeconomic indicators. The resulting analysis and discussion enable us to identify a set of possible "independent" factors explaining the developments of credibility. Our paper is composed as follows. Chapter 2 presents the theoretical model and its dynamics. Subsequent chapters are devoted to individual countries and contain empirical estimation of the model and the discussion of results. Chapters 3-10 contain studies of Poland, Bulgaria, Estonia, Lithuania, Latvia, Moldova and Georgia. Finally, chapter 11 concludes with summary of results and findings.