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Monetary Policies for Developing Countries: The Role of Institutional Quality

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  • Huang, Haizhou
  • Wei, Shang-Jin

Abstract

Weak public institutions, including high levels of corruption, characterize many developing countries. With a simple model, we demonstrate that institutional quality has important implications for the design of monetary policies and can produce several departures from the conventional wisdom. We find that a pegged exchange rate or dollarization, while sometimes prescribed as a solution to the problem of a lack of credibility, is typically not appropriate in developing countries with poor institutions. Such an arrangement is inferior to an optimal inflation targeting, or a Rogoff-style central banker, whose optimal degree of conservatism is proportional to the quality of institutions. Furthermore, our results cast doubt on the notion that a low inflationary target or a currency board can be used as an instrument to induce governments to strengthen quality of public institutions.

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  • Huang, Haizhou & Wei, Shang-Jin, 2005. "Monetary Policies for Developing Countries: The Role of Institutional Quality," CEPR Discussion Papers 4911, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4911
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    Keywords

    conservative central banker; corruption; currency board; dollarization; inflation targeting; institutional quality; monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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