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Fiscal Discipline and Exchange Rate Regimes; Evidence From the Caribbean


  • Rupa Duttagupta
  • Guillermo Tolosa


This paper assesses the nature of fiscal discipline under alternative exchange rate regimes. First, it shows in a simple theoretical framework that fiscal agencies under a currency union with a fixed exchange rate can have the largest incentive to overspend or "free-ride" (compared to those under other exchange rate regimes) owing to their ability to spread the costs of overspending in terms of the inflation tax across both time-given the fixed exchange rate-and space-given the currency union. In contrast, such free-riding behavior does not arise under flexible regimes owing to the immediate inflationary impact of spending. Next, empirically, it shows that fiscal stances in countries with fixed pegs and currency unions regime demonstrate greater free-riding behavior than countries with more flexible regimes in 15 Caribbean countries during 1983-2004.

Suggested Citation

  • Rupa Duttagupta & Guillermo Tolosa, 2006. "Fiscal Discipline and Exchange Rate Regimes; Evidence From the Caribbean," IMF Working Papers 06/119, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:06/119

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    References listed on IDEAS

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    Cited by:

    1. Rui Ota & Stephanie Medina Cas, 2008. "Big Government, High Debt, and Fiscal Adjustment in Small States," IMF Working Papers 08/39, International Monetary Fund.
    2. João Tovar Jalles & Carlos Mulas-Granados & José Tavares, 2016. "Fiscal Discipline and Exchange Rates; Does Politics Matter?," IMF Working Papers 16/230, International Monetary Fund.
    3. Shaun K. Roache, 2007. "Public Investment and Growth in the Eastern Caribbean," IMF Working Papers 07/124, International Monetary Fund.
    4. Hallerberg, Mark & Wolff, Guntram B., 2006. "Fiscal institutions, fiscal policy and sovereign risk premia," Discussion Paper Series 1: Economic Studies 2006,35, Deutsche Bundesbank.


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