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Monetary Policies for Developing Countries: The Role of Institutional Quality

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  • Huang, Haizhou
  • Wei, Shang-Jin

Abstract

Weak public institutions, including high levels of corruption, characterize many developing countries. With a simple model, we demonstrate that institutional quality has important implications for the design of monetary policies and can produce several departures from the conventional wisdom. We find that a pegged exchange rate or dollarization, while sometimes prescribed as a solution to the problem of a lack of credibility, is typically not appropriate in developing countries with poor institutions. Such an arrangement is inferior to an optimal inflation targeting, or a Rogoff-style central banker, whose optimal degree of conservatism is proportional to the quality of institutions. Furthermore, our results cast doubt on the notion that a low inflationary target or a currency board can be used as an instrument to induce governments to strengthen quality of public institutions.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4911.

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Date of creation: Feb 2005
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Handle: RePEc:cpr:ceprdp:4911

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Keywords: conservative central banker; corruption; currency board; dollarization; inflation targeting; institutional quality; monetary policy;

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