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Credibility of Policies versus Credibility of Policymakers

  • Drazen, Allan
  • Masson, Paul R

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 signaling 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 EMS interest rates and find support for our hypothesis. Copyright 1994, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Article provided by MIT Press in its journal Quarterly Journal of Economics.

Volume (Year): 109 (1994)
Issue (Month): 3 (August)
Pages: 735-54

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Handle: RePEc:tpr:qjecon:v:109:y:1994:i:3:p:735-54
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  1. Maurice Obstfeld., 1996. "Destabilizing Effects of Exchange-Rate Escape Clauses," Center for International and Development Economics Research (CIDER) Working Papers C96-075, University of California at Berkeley.
  2. Kenneth Rogoff, 1986. "Reputational Constraints on Monetary Policy," NBER Working Papers 1986, National Bureau of Economic Research, Inc.
  3. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
  4. Persson, Torsten, 1988. "An introduction and a broad survey," European Economic Review, Elsevier, vol. 32(2-3), pages 519-532, March.
  5. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July.
  6. Kreps, David M. & Wilson, Robert, 1982. "Reputation and imperfect information," Journal of Economic Theory, Elsevier, vol. 27(2), pages 253-279, August.
  7. Francesco Giavazzi & Marco Pagano, 1991. "The Advantage of Tying One's Hands: EMS Discipline and Central Bank Credibility," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 303-330 National Bureau of Economic Research, Inc.
  8. 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.
  9. 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.
  10. Blanchard, Olivier J., 1985. "Credibility, disinflation and gradualism," Economics Letters, Elsevier, vol. 17(3), pages 211-217.
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