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Credibility of Policies versus Credibility of Policymakers

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Author Info
Allan Drazen
Paul R. Masson

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Abstract

Standard models of policy credibility. defined as the expectation that an announced policy will be carried out. emphasize the preferences of the policymaker (his "type") and the role of policies in signaling type. Whether a policy is carried out. however. should also reflect the state of the economy. so that even a "tough" policymaker may renege on an announced policy in adverse circumstances. We investigate this alternative notion of credibility, using an "escape clause" model of devaluation. 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 the process driving unemployment, following a tough policy in a given period may lower rather than raise the credibility of a no-devaluation pledge in subsequent periods. in contrast to the results in the earlier literature. We test this implication on EMS interest rates and find support for our hypothesis.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4448.

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Date of creation: Sep 1993
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Handle: RePEc:nbr:nberwo:4448

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Find related papers by JEL classification:
E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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  1. Kreps, David M. & Wilson, Robert, 1982. "Reputation and imperfect information," Journal of Economic Theory, Elsevier, vol. 27(2), pages 253-279, August. [Downloadable!] (restricted)
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  2. Persson, Torsten, 1988. "An introduction and a broad survey," European Economic Review, Elsevier, vol. 32(2-3), pages 519-532, March. [Downloadable!] (restricted)
  3. Obstfeld, Maurice, 1991. "Destabilizing Effects of Exchange-Rate Escape Clauses," CEPR Discussion Papers 518, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  4. Kenneth A. Froot & Kenneth Rogoff, 1991. "The EMS, the EMU, and the Transition to a Common Currency," NBER Working Papers 3684, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Blanchard, Olivier J., 1985. "Credibility, disinflation and gradualism," Economics Letters, Elsevier, vol. 17(3), pages 211-217. [Downloadable!] (restricted)
  6. Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation, Yale University. [Downloadable!]
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  7. 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. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
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  9. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
  10. Rogoff, Kenneth, 1987. "Reputational constraints on monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 141-181, January. [Downloadable!] (restricted)
  11. Kenneth Rogoff, 1987. "Reputational Constraints on Monetary Policy," NBER Working Papers 1986, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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