The Political Economy of External Discipline: Constraint Versus Incentive Effects of Capital Mobility and Exchange Rate Pegs
This paper argues that while sources of potential discipline over domestic macro economic policies such as pegged exchange rates, high capital mobility, and IMF policy conditionality are commonly viewed as constraints, it is usually more productive to view them as influencing incentive structures in a world of multiple relevant actors. From this perspective, pegged, as opposed to genuinely fixed exchange rates, are typically not an adequate substitute for domestic discipline enhancing measures. The micro level political economy analysis presented suggests serious limits to the effectiveness of external strategies as sources of discipline. Indeed, their effects can sometimes be perverse. For example, high capital mobility under fixed exchange rates can reduce short run discipline over fiscal policy and impede the ability of an independent central bank to counteract political business cycles in fiscal policy. The analysis highlights the problems of attempting to use commitment devices with asymmetric time profiles to overcome problems generated by the asymmetric short run effects of discretionary monetary and fiscal policies. In particular exchange rate pegging gives front loaded benefits and delayed costs. This makes for a particularly inefficient strategy for trying to avoid domestic macro economic time inconsistency problems. Where short time horizons greatly discount the prospective future costs of a currency crisis, the political incentives generated by pegged rates often fail to provide sufficient monetary and fiscal restraint to avoid such crises. They also tend to discourage the prompt adjustment of disequilibrium exchange rates. As a consequence, exit from a pegged regime is often delayed too long and currency crises result. Thus the political incentive structures generated by exchange rate pegging can be as great a source of difficulty for the smooth operation of intermediate exchange rate regimes as are the economic forces of high capital mobility stressed by many economists. The overall thrust of this paper is to suggest that external sources of discipline over macroeconomic policies are often weak and sometimes perverse. For many, and perhaps most countries, the primary focus for discipline should be internal.
|Date of creation:||Aug 2001|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: (909) 607-3041
Fax: (909) 621-8249
Web page: http://www.claremontmckenna.edu/rdschool/papers/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Keefer, Philip & Stasavage, David, 2002.
"Checks and Balances, Private Information, and the Credibility of Monetary Commitments,"
Cambridge University Press, vol. 56(04), pages 751-774, September.
- Keefer, Philip & Stasavage, David, 2001. "Checks and balances, private information, and the credibility of monetary commitments," Policy Research Working Paper Series 2542, The World Bank.
- David Romer, 1991.
"Openness and Inflation: Theory and Evidence,"
NBER Working Papers
3936, National Bureau of Economic Research, Inc.
- 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.
- Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
- Reuven Glick, 2000.
"Fixed or floating: is it still possible to manage in the middle?,"
Pacific Basin Working Paper Series
2000-02, Federal Reserve Bank of San Francisco.
- Glick, R., 2000. "Fixed or Floating: Is It Still Possible to Manage in the Middle?," Papers pb00-02, Economisch Institut voor het Midden en Kleinbedrijf-.
- Andrews, David M. & Willett, Thomas D., 1997. "Financial Interdependence and the State: International Monetary Relations at Century's End," International Organization, Cambridge University Press, vol. 51(03), pages 479-511, June.
- Robert H. Bates & Avner Greif & Margaret Levi & Jean-Laurent Rosenthal, 1998. "Analytic Narratives," Economics Books, Princeton University Press, edition 1, volume 1, number 6355.
- Alberto Alesina & Gerald D. Cohen & Nouriel Roubini, 1991.
"Macroeconomic Policy and Elections in OECD Democracies,"
NBER Working Papers
3830, National Bureau of Economic Research, Inc.
- Alesina, Alberto F & Cohen, Gerald D & Roubini, Nouriel, 1992. "Macroeconomic Policy and Elections in OECD Democracies," CEPR Discussion Papers 608, C.E.P.R. Discussion Papers.
- Bayoumi, Tamim & Eichengreen, Barry, 1998.
"Exchange Rate Volatility and Intervention: Implications of the Theory of Optimum Currency Areas,"
CEPR Discussion Papers
1982, C.E.P.R. Discussion Papers.
- Bayoumi, Tamim & Eichengreen, Barry, 1998. "Exchange rate volatility and intervention: implications of the theory of optimum currency areas," Journal of International Economics, Elsevier, vol. 45(2), pages 191-209, August.
- Francesco Giavazzi & Marco Pagano, 1991.
"The Advantage of Tying One's Hands: EMS Discipline and Central Bank Credibility,"
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.
- 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.
- Giavazzi, Francesco & Pagano, Marco, 1986. "The Advantages of Tying One's Hands: EMS Discipline and Central Bank Credibility," CEPR Discussion Papers 135, C.E.P.R. Discussion Papers.
- Ernesto H. Stein & Natalia Salazar & Roberto Steiner & Eugenio Díaz-Bonilla & Marco Bonomo & Juan C. Jaramillo & Hector E. Schamis & Alberto Pascó-Front & Piero Ghezzi & Maria Cristina Terra & José De, 2001. "The Currency Game: Exchange Rate Politics in Latin America," IDB Publications (Books), Inter-American Development Bank, number 77398 edited by Ernesto H. Stein & Jeffry Frieden, October.
- repec:idb:brikps:77398 is not listed on IDEAS
- Thomas D. Willett & Fahim Al-Marhubi, 1994. "Currency Policies for Inflation Control in the Formerly Centrally Planned Economies," The World Economy, Wiley Blackwell, vol. 17(6), pages 795-815, November.
- Clark, William Roberts & Reichert, Usha Nair & Lomas, Sandra Lynn & Parker, Kevin L., 1998. "International and Domestic Constraints on Political Business Cycles in OECD Economies," International Organization, Cambridge University Press, vol. 52(01), pages 87-120, December.
- Bird, Graham, 1996. "The International Monetary Fund and developing countries: a review of the evidence and policy options," International Organization, Cambridge University Press, vol. 50(03), pages 477-511, June.
- Willett, Thomas D. & Keil, Manfred W. & Ahn, Young Seok, 2002. "Capital mobility for developing countries may not be so high," Journal of Development Economics, Elsevier, vol. 68(2), pages 421-434, August.
- Barry J. Eichengreen & Inci Ã–tker & A. Javier Hamann & Esteban Jadresic & R. B. Johnston & Hugh Bredenkamp & Paul R. Masson, 1998. "Exit Strategies: Policy Options for Countries Seeking Exchange Rate Flexibility," IMF Occasional Papers 168, International Monetary Fund.
- Krugman, P., 1993. "What Do We Need to Know About the International Monetary System?," Princeton Studies in International Economics 190, International Economics Section, Departement of Economics Princeton University,.
- Chan Huh, 1997. "Inflation targeting," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb7.
- Thomas D. Willett, 2000. "The Need for a Political Economy Capability at the IMF," Claremont Colleges Working Papers 2000-55, Claremont Colleges.
When requesting a correction, please mention this item's handle: RePEc:clm:clmeco:2001-29. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.