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Fiscal Discipline and Exchange Rate Regimes

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Author Info
Canzoneri, Matthew B
Cumby, Robert
Diba, Behzad

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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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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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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Alfredo Baldini & Marcos Poplawski Ribeiro, 2008. "Fiscal and Monetary Anchors for Price Stability: Evidence from Sub-Saharan Africa," IMF Working Papers 08/121, International Monetary Fund. [Downloadable!]
  2. Betty Daniel, 2000. "A Fiscal Theory of Currency Crises," Econometric Society World Congress 2000 Contributed Papers 0535, Econometric Society. [Downloadable!]
    Other versions:
  3. 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. [Downloadable!] (restricted)
    Other versions:
  4. Mauro Visaggio, 2004. "Does Stability and Growth Pact Provide an Adequate and Consistent Fiscal Rule?," Macroeconomics 0407008, EconWPA. [Downloadable!]
  5. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. 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. [Downloadable!] (restricted)
  7. Giorgio Pizzutto, 1998. "La Teoria Fiscale dei Prezzi In un'Economia Aperta," Departemental Working Papers 1998-07, Department of Economics University of Milan Italy. [Downloadable!]
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