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Importing Credibility Through Exchange Pegging

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  • Herrendorf, Berthold

Abstract

This paper employs an optimal taxation framework in order to study the credibility of monetary policy-making in an open economy. Since inflation is, in part, uncontrollable due to stochastic disturbances, the authority's actions cannot be monitored perfectly when exchange rate floats, thus implying that the reputational forces may become ineffective. In contrast, pegging the nominal exchange rate to a low-inflation currency allows perfect monitoring, because the exchange rate is, in principle, controllable. For this reason, exchange rate pegging may import credibility and result in the best reputational equilibrium, even though the authority retains the discretion to devalue unexpectedly.

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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 446.

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Length: 12 pages
Date of creation: 1996
Date of revision:
Handle: RePEc:wrk:warwec:446

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Related research

Keywords: Credibility ; Exchange Rate Pegging ; Incomplete Information ; Inflation Tax ; Reputation;

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