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Pegged Exchange Rate Regimes-A Trap?

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  • JOSHUA AIZENMAN
  • REUVEN GLICK

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. Copyright (c) 2008 The Ohio State University.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 40 (2008)
Issue (Month): 4 (06)
Pages: 817-835

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Handle: RePEc:mcb:jmoncb:v:40:y:2008:i:4:p:817-835

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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References

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  1. Robert Flood & Nancy Marion, 1998. "Perspectives on the Recent Currency Crisis Literature," NBER Working Papers 6380, National Bureau of Economic Research, Inc.
  2. Cukierman, Alex & Liviatan, Nissan, 1991. "Optimal accommodation by strong policymakers under incomplete information," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 99-127, February.
  3. Maurice Obstfeld, 1997. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc.
  4. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc.
  5. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  6. Barry J. Eichengreen & Inci Ötker & A. Javier Hamann & Esteban Jadresic & R. B. Johnston & Hugh Bredenkamp & Paul R. Masson, 1998. "Exit Strategies: Policy Options for Countries Seeking Exchange Rate Flexibility," IMF Occasional Papers 168, International Monetary Fund.
  7. Eichengreen, Barry, 1999. "Kicking the Habit: Moving from Pegged Rates to Greater Exchange Rate Flexibility," Economic Journal, Royal Economic Society, vol. 109(454), pages C1-14, March.
  8. Enrica Detragiache & Eisuke Okada & Ashoka Mody, 2005. "Exits from Heavily Managed Exchange Rate Regimes," IMF Working Papers 05/39, International Monetary Fund.
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Cited by:
  1. Joshua Aizenman & Menzie D. Chinn & Hiro Ito, 2008. "Assessing the Emerging Global Financial Architecture: Measuring the Trilemma's Configurations over Time," NBER Working Papers 14533, National Bureau of Economic Research, Inc.
  2. Aizenman, Joshua & Glick, Reuven, 2008. "Sovereign Wealth Funds: Stylized Facts about their Determinants and Governance," Santa Cruz Department of Economics, Working Paper Series qt1fj4b203, Department of Economics, UC Santa Cruz.
  3. Joshua Aizenman & Reuven Glick, 2010. "Asset class diversification and delegation of responsibilities between central banks and sovereign wealth funds," Working Paper Series 2010-20, Federal Reserve Bank of San Francisco.
  4. Frederic S. Mishkin, 2006. "Monetary Policy Strategy: How Did We Get Here?," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 53(4), pages 359-388, December.
  5. Joshua Aizenman & Reuven Glick, 2009. "Sterilization, Monetary Policy, and Global Financial Integration," Review of International Economics, Wiley Blackwell, vol. 17(4), pages 777-801, 09.
  6. Tamgac, Unay, 2013. "Duration of fixed exchange rate regimes in emerging economies," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 439-467.
  7. Glick, Reuven & Hutchison, Michael, 2009. "Navigating the trilemma: Capital flows and monetary policy in China," Journal of Asian Economics, Elsevier, vol. 20(3), pages 205-224, May.
  8. Ahmet Atil Asici, 2010. "Parametric and non-parametric approaches to exits from fixed exchange rate regimes," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(4), pages 381-406.
  9. Frederic S. Mishkin, 2007. "Comment on "Monetary Rules in Emerging Economies with Financial Market Imperfections"," NBER Chapters, in: International Dimensions of Monetary Policy, pages 311-317 National Bureau of Economic Research, Inc.

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