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Credibility of Policies Versus Credibility of Policymakers

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  • Paul R. Masson
  • Allan Drazen

Abstract

Standard models of policy credibility, defined as the expectation that an announced policy will be carried out, emphasize the preferences of the policymaker, and the role of tough policies in signalling toughness and raising credibility. Whether a policy is carried out, however, will also reflect the state of the economy. We present a model in which a policymaker maintains a fixed parity in good times, but devalues if the unemployment rate gets too high. Our main conclusion is that if there is persistence in unemployment, observing a tough policy in a given period may lower rather than raise the credibility of a no-devaluation pledge in subsequent periods. We test this implication on data for the interest rate differential between France and Germany and find support for our hypothesis.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 94/49.

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Length: 28
Date of creation: 01 May 1994
Date of revision:
Handle: RePEc:imf:imfwpa:94/49

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  1. Blanchard, Olivier J., 1985. "Credibility, disinflation and gradualism," Economics Letters, Elsevier, vol. 17(3), pages 211-217.
  2. David Kreps & Robert Wilson, 1999. "Reputation and Imperfect Information," Levine's Working Paper Archive 238, David K. Levine.
  3. Giavazzi, Francesco & Pagano, Marco, 1988. "The advantage of tying one's hands : EMS discipline and Central Bank credibility," European Economic Review, Elsevier, vol. 32(5), pages 1055-1075, June.
  4. Persson, Torsten, 1988. "An introduction and a broad survey," European Economic Review, Elsevier, vol. 32(2-3), pages 519-532, March.
  5. Obstfeld, Maurice, 1997. "Destabilizing effects of exchange-rate escape clauses," Journal of International Economics, Elsevier, vol. 43(1-2), pages 61-77, August.
  6. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
  7. Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
  8. Rogoff, Kenneth, 1987. "Reputational constraints on monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 141-181, January.
  9. Kenneth A. Froot & Kenneth Rogoff, 1991. "The EMS, the EMU, and the Transition to a Common Currency," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 269-328 National Bureau of Economic Research, Inc.
  10. Vickers, John, 1986. "Signalling in a Model of Monetary Policy with Incomplete Information," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 443-55, November.
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