We analyze the role of an exchange rate peg as a commitment mechanism to achieve inflation stability when multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative regime not only in order to mitigate inflation bias from time inconsistency but also to avoid high inflation equilibria. In these circumstances, using a pegged exchange rate as an anti-inflation commitment device can create a "trap" whereby the regime initially confers gains in anti-inflation credibility but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy.
|Number of pages||19|
|Journal||Journal of Money, Credit and Banking|
|State||Published - 1 Jan 2008|
- Monetary regime change
- Pegged exchange rate
ASJC Scopus subject areas
- Economics and Econometrics