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Importing Credibility Through Exchange Pegging

Author

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  • Herrendorf, Berthold

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 exchange rate floats, thus implying that the 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.

Suggested Citation

  • Herrendorf, Berthold, 1996. "Importing Credibility Through Exchange Pegging," The Warwick Economics Research Paper Series (TWERPS) 446, University of Warwick, Department of Economics.
    • Handle: RePEc:wrk:warwec:446
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    File URL: https://warwick.ac.uk/fac/soc/economics/research/workingpapers/1995-1998/twerp446.pdf
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    Cited by:

    1. Canavan, Chris & Tommasi, Mariano, 1997. "On the credibility of alternative exchange rate regimes," Journal of Development Economics, Elsevier, vol. 54(1), pages 101-122, October.

    More about this item

    Keywords

    Credibility ; Exchange Rate Pegging ; Incomplete Information ; Inflation Tax ; Reputation;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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