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Fiscal Discipline and Exchange Rate Regimes

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  • Canzoneri, Matthew B
  • Cumby, Robert
  • Diba, Behzad

Abstract

This paper explores the implications of a new theory of price determination (due to Leeper, Woodford and Sims) for the maintenance of various exchange rate systems – crawling pegs, fixed pegs, and common currency areas. It shows that deeper monetary integration requires more fiscal discipline, especially if price stability is an objective; these monetary arrangements cannot be achieved by monetary policy alone, as conventional wisdom would seem to suggest. A particularly striking result is that a currency peg is simply not sustainable if fiscal surpluses are determined by an exogenous political process; maintenance of a fixed currency peg requires the government to guarantee fiscal solvency for any equilibrium sequence of prices (which Woodford calls a Ricardian Regime). Interestingly, the debt and deficit constraints that were written into the Maastricht Treaty, and will continue in the Stability Pact after EMU, are examples of the fiscal discipline that is required.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1899.

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Date of creation: May 1998
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Handle: RePEc:cpr:ceprdp:1899

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Related research

Keywords: Exchange Rate Regimes; Fiscal Discipline; price determination;

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Citations

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Cited by:
  1. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc.
  2. International Monetary Fund, 2008. "Fiscal and Monetary Anchors for Price Stability: Evidence from Sub-Saharan Africa," IMF Working Papers 08/121, International Monetary Fund.
  3. M. Marzo, 2001. "An Equilibrium Approach to the Term Structure of Interest rates with the Interaction between Monetary and Fiscal Policy," Working Papers 410, Dipartimento Scienze Economiche, Universita' di Bologna.
  4. Betty Daniel, 2000. "A Fiscal Theory of Currency Crises," Econometric Society World Congress 2000 Contributed Papers 0535, Econometric Society.
  5. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2001. "Is the Price Level Determined by the Needs of Fiscal Solvency?," American Economic Review, American Economic Association, vol. 91(5), pages 1221-1238, December.
  6. M. Marzo, 2001. "Monetary and Fiscal Policy Interactions: the Impact on the Term Structure of Interest Rates," Working Papers 409, Dipartimento Scienze Economiche, Universita' di Bologna.
  7. Giorgio Pizzutto, 1998. "La Teoria Fiscale dei Prezzi In un'Economia Aperta," Departmental Working Papers 1998-07, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
  8. Mauro Visaggio, 2004. "Does Stability and Growth Pact Provide an Adequate and Consistent Fiscal Rule?," Macroeconomics 0407008, EconWPA.
  9. John Lewis, 2007. "Fiscal policy in central and Eastern Europe: what happened in the run-up to EU accession?," International Economics and Economic Policy, Springer, vol. 4(1), pages 15-31, April.
  10. Järvinen, Marketta, 2002. "Exchange rate regimes and nominal convergence in the CEECs," BOFIT Discussion Papers 4/2002, Bank of Finland, Institute for Economies in Transition.

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