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Fiscal Discipline and Stability under Currency Board Systems

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Author Info
Oliver Grimm () (Center of Economic Research (CER-ETH) at ETH Zurich)

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

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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References listed on IDEAS
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  1. Fatás, Antonio & Rose, Andrew K, 2001. "Do Monetary Handcuffs Restrain Leviathan? Fiscal Policy in Extreme Exchange Rate Regimes," CEPR Discussion Papers 2692, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  2. Tornell, Aaron & Velasco, Andres, 1995. "Fixed Versus Flexible Exchange Rates: Which Provides More Fiscal Discipline," Working Papers 95-06, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  3. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  4. Helge Berger & Henrik Jensen & Guttorm Schjelderup, 2001. "To Peg or Not To Peg? A Simple Model of Exchange Rate Regime Choice In Small Economies," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  5. Oliva, Maria-Angels & Rivera-Batiz, Luis A & Sy, Amadou N R, 2001. "Discipline, Signaling, and Currency Boards," Review of International Economics, Blackwell Publishing, vol. 9(4), pages 608-25, November. [Downloadable!] (restricted)
  6. 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, vol. 91(4), pages 589-610, August. [Downloadable!] (restricted)
    Other versions:
  7. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1996. "The Mexican Peso Crisis: Sudden Death or Death Foretold?," NBER Working Papers 5563, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Switgard Feuerstein & Oliver Grimm, 2004. "On the Credibility of Currency Boards," cege – Center for European, Governance and Economic Development Research Discussion Papers 36, cege – Center for European, Governance and Economic Development Research, University of Goettingen (Germany).. [Downloadable!]
    Other versions:
  10. Luis Catão & Marco Terrones, 2003. "Fiscal Deficits and Inflation," IMF Working Papers 03/65, International Monetary Fund. [Downloadable!]
    Other versions:
  11. Gregor Irwin, 2004. "Currency boards and currency crises," Oxford Economic Papers, Oxford University Press, vol. 56(1), pages 64-87, January.
  12. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2000. "Currency boards: More than a quick fix?," Economic Policy, CEPR, CES, MSH, vol. 15(31), pages 269-335, October. [Downloadable!] (restricted)
  13. Carlson, John A. & Valev, Neven T., 2001. "Credibility of a new monetary regime: The currency board in Bulgaria," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 581-594, June. [Downloadable!] (restricted)
  14. Tornell, Aaron & Velasco, Andres, 1995. "Money-Based Versus Exchange Rate-Based Stabilization with Endogenous Fiscal Policy," Working Papers 95-21, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  15. Corrinne Ho, 2002. "A survey of the institutional and operational aspects of modern-day currency boards," BIS Working Papers 110, Bank for International Settlements. [Downloadable!]
  16. De la Torre, Augusto & Levy Yeyati, Eduardo & Schmukler, Sergio L., 2003. "Living and dying with hard pegs : the rise and fall of Argentina's currency board," Policy Research Working Paper Series 2980, The World Bank. [Downloadable!]
    Other versions:
  17. Tornell, Aaron & Velasco, Andres, 1998. "Fiscal discipline and the choice of a nominal anchor in stabilization," Journal of International Economics, Elsevier, vol. 46(1), pages 1-30, October. [Downloadable!] (restricted)
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