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Policy Signaling in the Open Economy: A Re-Examination

  • Allan Drazen

The standard model of signaling used in open economy macroeconomics concentrates on building a reputation when a policymaker's `type' is unknown. Observing tough policy leads market participants to raise the probability that a policymaker is tough, and therefore to expect tough policy in the future. This approach leaves unexplained a number of commonly observed occurrences, for example, toughness in defending an exchange rate leading to increased speculation against the currency. To explain many phenomena, this paper argues, more sophisticated signaling models are needed, models which include signaling of resources rather than preferences, policy affecting the environment in which signals are sent, and exogenous changes in the environment affecting the informativeness of signals. These models are explored and are shown to be able to explain a number of phenomena the standard reputational model cannot.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5892.

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Date of creation: Jan 1997
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Publication status: published as Wolf, H. (ed.) Contemporary Economic Development Reviewed, vol. 5, Macroeconomic Policy and Financial Systems. London: Macmillan, 1997.
Handle: RePEc:nbr:nberwo:5892
Note: EFG IFM
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  1. Maurice Obstfeld., 1996. "Destabilizing Effects of Exchange-Rate Escape Clauses," Center for International and Development Economics Research (CIDER) Working Papers C96-075, University of California at Berkeley.
  2. Allan Drazen & Paul R. Masson, 1993. "Credibility of Policies versus Credibility of Policymakers," NBER Working Papers 4448, National Bureau of Economic Research, Inc.
  3. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 370-84, April.
  4. Francesco Giavazzi & Luigi Spaventa, 1990. "The "New" EMS," Working Papers 86, Dipartimento Scienze Economiche, Universita' di Bologna.
  5. Leonardo Bartolini & Allan Drazen, 1996. "Capital Account Liberalization as a Signal," NBER Working Papers 5725, National Bureau of Economic Research, Inc.
  6. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  7. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  8. Susanne Lohmann, 1990. "Monetary Policy Strategies: A Correction: Comment on Flood and Isard," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 440-445, June.
  9. Persson, Torsten, 1988. "An introduction and a broad survey," European Economic Review, Elsevier, vol. 32(2-3), pages 519-532, March.
  10. Liviatan, Nissan, 1984. "Tight money and inflation," Journal of Monetary Economics, Elsevier, vol. 13(1), pages 5-15, January.
  11. Blanchard, Olivier J., 1985. "Credibility, disinflation and gradualism," Economics Letters, Elsevier, vol. 17(3), pages 211-217.
  12. Drazen, Allan, 1985. "Tight money and inflation: Further Results," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 113-120, January.
  13. Kenneth Rogoff, 1986. "Reputational Constraints on Monetary Policy," NBER Working Papers 1986, National Bureau of Economic Research, Inc.
  14. Frank Hahn, 1985. "Money and Inflation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262580624, June.
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