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Fiscal Discipline and Stability under Currency Board Systems

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Abstract

In economic discussions, currency board systems are frequently described as arrangements with self-binding character to the monetary authorities by their strict rules and establishments by law. Hard pegs and especially currency boards are often seen as remedies to overcome economic and financial turmoils and to return to low inflation. A sustainable debt level closely linked to a disciplined fiscal policy is, however, a premise for medium-term success. We show in a two-period model that the choice of a currency board can increase fiscal discipline compared to a standard peg regime. We derive, furthermore, the conditions for a currency boards to gain a stability advantage compared to a common peg system.

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Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 07/66.

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Length: 58 pages
Date of creation: Mar 2007
Date of revision:
Handle: RePEc:eth:wpswif:07-66

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Keywords: currency board; fixed exchange rate; commitment; inflation bias; fiscal discipline; public debt; time-inconsistency problem;

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  1. Chang, R. & Velasco, A., 1998. "Financial Fragility and the Exchange Rate Regime," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-05, C.V. Starr Center for Applied Economics, New York University.
  2. Catao, Luis A.V. & Terrones, Marco E., 2005. "Fiscal deficits and inflation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 52(3), pages 529-554, April.
  3. Enrique Alberola & Luis Molina, 2000. "Fiscal Discipline and Exchange Rate Regimes: a Case for Currency Boards?," Banco de Espa�a Working Papers 0006, Banco de Espa�a.
  4. Feuerstein, Switgard & Grimm, Oliver, 2004. "On the Credibility of Currency Boards," Center for European, Governance and Economic Development Research Discussion Papers 36, University of Goettingen, Department of Economics.
  5. Gregor Irwin, 2004. "Currency boards and currency crises," Oxford Economic Papers, Oxford University Press, vol. 56(1), pages 64-87, January.
  6. Oliva, Maria-Angels & Rivera-Batiz, Luis A & Sy, Amadou N R, 2001. "Discipline, Signaling, and Currency Boards," Review of International Economics, Wiley Blackwell, vol. 9(4), pages 608-25, November.
  7. Maurice Obstfeld, 1995. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc.
  8. Corrinne Ho, 2002. "A survey of the institutional and operational aspects of modern-day currency boards," BIS Working Papers 110, Bank for International Settlements.
  9. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2000. "Currency boards: More than a quick fix?," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 15(31), pages 269-335, October.
  10. Augusto de la Torre & Eduardo Levy Yeyati & Sergio L. Schmukler, 2003. "Living and Dying with Hard Pegs: The Rise and Fall of Argentina's Currency Board," JOURNAL OF LACEA ECONOMIA, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  11. Dalia Grigonyté, 2003. "Impact of Currency Boards on Fiscal Policy in Central and Eastern European Countries," Economic Change and Restructuring, Springer, Springer, vol. 36(2), pages 111-133, June.
  12. Berger, Helge & Jensen, Henrik & Schjelderup, Guttorm, 2001. "To peg or not to peg?: A simple model of exchange rate regime choice in small economies," Economics Letters, Elsevier, Elsevier, vol. 73(2), pages 161-167, November.
  13. Tornell, Aaron & Velasco, Andres, 1998. "Fiscal discipline and the choice of a nominal anchor in stabilization," Journal of International Economics, Elsevier, Elsevier, vol. 46(1), pages 1-30, October.
  14. Fatás, Antonio & Rose, Andrew K, 2001. "Do Monetary Handcuffs Restrain Leviathan? Fiscal Policy in Extreme Exchange Rate Regimes," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2692, C.E.P.R. Discussion Papers.
  15. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 589-610, August.
  16. Carlson, John A. & Valev, Neven T., 2001. "Credibility of a new monetary regime: The currency board in Bulgaria," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(3), pages 581-594, June.
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