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Fear of Floating and Social Welfare

This paper studies the welfare implications of financial stability and inflation stabilization as distinct monetary policy objectives. Introducing asymmetric aversion to exchange rate depreciation in the Barro-Gordon model mitigates inflation bias due to credibility problems. The net welfare impact of fear of floating depends on the economy’s recent track record, the credibility of monetary policy, and the central bank’s discount factor. It is shown that fear of floating is more appropriate for financially fragile developing countries with imperfectly credible monetary policy than for advanced economies.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0726.

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Length: 29
Date of creation: May 2007
Date of revision:
Handle: RePEc:cam:camdae:0726
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