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Credibility of Policies Versus Credibility of Policymakers

  • Paul R. Masson
  • Allan Drazen

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 signalling 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 data for the interest rate differential between France and Germany and find support for our hypothesis.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 94/49.

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Length: 28
Date of creation: 01 May 1994
Date of revision:
Handle: RePEc:imf:imfwpa:94/49
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  1. Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
  2. 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.
  3. Kreps, David M. & Wilson, Robert, 1982. "Reputation and imperfect information," Journal of Economic Theory, Elsevier, vol. 27(2), pages 253-279, August.
  4. Obstfeld, Maurice, 1996. "Destabilizing Effects of Exchange-Rate Escape Clauses," Department of Economics, Working Paper Series qt15n3p5dt, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Kenneth Froot & Kenneth Rogoff & Olivier Blanchard & Stanley Fischer, . "The EMS, the EMU, and the Transition to a Common Currency," Working Paper 32216, Harvard University OpenScholar.
  6. 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.
  7. Blanchard, Olivier J., 1985. "Credibility, disinflation and gradualism," Economics Letters, Elsevier, vol. 17(3), pages 211-217.
  8. Kenneth Rogoff, 1986. "Reputational Constraints on Monetary Policy," NBER Working Papers 1986, National Bureau of Economic Research, Inc.
  9. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
  10. Persson, Torsten, 1988. "An introduction and a broad survey," European Economic Review, Elsevier, vol. 32(2-3), pages 519-532, March.
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