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Policy Signaling in the Open Economy: A Re-Examination

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  • Allan Drazen

Abstract

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.

Suggested Citation

  • Allan Drazen, 1997. "Policy Signaling in the Open Economy: A Re-Examination," NBER Working Papers 5892, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:5892
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    References listed on IDEAS

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    1. Persson, Torsten, 1988. "An introduction and a broad survey," European Economic Review, Elsevier, vol. 32(2-3), pages 519-532, March.
    2. 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.
    3. Bartolini, Leonardo & Drazen, Allan, 1997. "Capital-Account Liberalization as a Signal," American Economic Review, American Economic Association, vol. 87(1), pages 138-154, March.
    4. Frank Hahn, 1985. "Money and Inflation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262580624, January.
    5. Allan Drazen & Paul R. Masson, 1994. "Credibility of Policies Versus Credibility of Policymakers," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 735-754.
    6. Obstfeld, Maurice, 1997. "Destabilizing effects of exchange-rate escape clauses," Journal of International Economics, Elsevier, vol. 43(1-2), pages 61-77, August.
    7. Blanchard, Olivier J., 1985. "Credibility, disinflation and gradualism," Economics Letters, Elsevier, vol. 17(3), pages 211-217.
    8. Liviatan, Nissan, 1984. "Tight money and inflation," Journal of Monetary Economics, Elsevier, vol. 13(1), pages 5-15, January.
    9. Rogoff, Kenneth, 1987. "Reputational constraints on monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 141-181, January.
    10. Giavazzi, Francesco & Spaventa, Luigi, 1990. "The `New' EMS," CEPR Discussion Papers 369, C.E.P.R. Discussion Papers.
    11. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, January.
    12. 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.
    13. 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 370-384, April.
    14. Drazen, Allan, 1985. "Tight money and inflation: Further Results," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 113-120, January.
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    Citations

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    Cited by:

    1. David M. Gould, 1999. "Does the choice of nominal anchor matter?," Center for Latin America Working Papers 0499, Federal Reserve Bank of Dallas.
    2. Reuven Glick & Michael Hutchison, "undated". "Stopping "Hot Money" or Signaling Bad Policy? Capital Controls and the Onset of Currency Crises," EPRU Working Paper Series 00-14, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    3. Fabrizio Carmignani & Emilio Colombo & Patrizio Tirelli, 2004. "Consistency versus credibility: how do countries choose their exchange rate regime?," Working Papers 85, University of Milano-Bicocca, Department of Economics, revised Feb 2005.
    4. Carmignani, Fabrizio & Colombo, Emilio & Tirelli, Patrizio, 2008. "Exploring different views of exchange rate regime choice," Journal of International Money and Finance, Elsevier, vol. 27(7), pages 1177-1197, November.

    More about this item

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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