Abstract
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.
Original language | English |
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Pages (from-to) | 817-835 |
Number of pages | 19 |
Journal | Journal of Money, Credit and Banking |
Volume | 40 |
Issue number | 4 |
DOIs | |
State | Published - 1 Jan 2008 |
Externally published | Yes |
Keywords
- Credibility
- Crises
- Discretion
- Duration
- Monetary regime change
- Pegged exchange rate
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics