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The Dangers of Exchange-Rate Pegging in Emerging-Market Countries

  • Mishkin, Frederic S

This paper examines the question of whether pegging exchange rates is a good strategy for emerging-market countries. Although pegging the exchange rate provides a nominal anchor for emerging-market countries that can help them to control inflation, the analysis in this paper does not provide support for this strategy for the conduct of monetary policy. First there are the usual criticisms of exchange-rate pegging, that it entails the loss of an independent monetary policy, exposes the country to the transmission of shocks from the anchor country, increases the likelihood of speculative attacks and potentially weakens the accountability of policymakers to pursue anti-inflationary policies. However, most damaging to the case for exchange-rate pegging in emerging-market countries is that it can increase financial fragility and heighten the potential for financial crises. Because of the devastating effects on the economy that financial crises can bring, an exchange-rate peg is a very dangerous strategy for controlling inflation in emerging-market countries. Instead, this paper suggests that a strategy with a greater likelihood of success involves the granting of independence to the central bank and the adoption of inflation targeting. Copyright 1998 by Blackwell Publishers Ltd.

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Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 1 (1998)
Issue (Month): 1 (October)
Pages: 81-101

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Handle: RePEc:bla:intfin:v:1:y:1998:i:1:p:81-101
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  1. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
  2. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  3. Frederic S. Mishkin, 1991. "Asymmetric Information and Financial Crises: A Historical Perspective," NBER Chapters, in: Financial Markets and Financial Crises, pages 69-108 National Bureau of Economic Research, Inc.
  4. Frederic S. Mishkin, 1994. "Preventing Financial Crises: An International Perspective," NBER Working Papers 4636, National Bureau of Economic Research, Inc.
  5. 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.
  6. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," NBER Working Papers 5191, National Bureau of Economic Research, Inc.
  7. Michael Sarel, 1996. "Nonlinear Effects of Inflation on Economic Growth," IMF Staff Papers, Palgrave Macmillan, vol. 43(1), pages 199-215, March.
  8. Oscar Landerretche & Felipe Morandé & Klaus Schmidt-Hebbe, 1999. "Inflation Targets and Stabilization in Chile," Working Papers Central Bank of Chile 55, Central Bank of Chile.
  9. Cukierman Alex, 1992. "Central Bank Strategy, Credibility, And Independance: Theory And Evidence," Journal des Economistes et des Etudes Humaines, De Gruyter, vol. 3(4), pages 10, December.
  10. Stanley Fischer, 1993. "The Role of Macroeconomic Factors in Growth," NBER Working Papers 4565, National Bureau of Economic Research, Inc.
  11. Bennett T. McCallum, 1996. "Crucial Issues Concerning Central Bank Independence," NBER Working Papers 5597, National Bureau of Economic Research, Inc.
  12. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc.
  13. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
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