Gains from Commitment: The Case for Pegging the Exchange Rate

Kai Arvai and Ricardo Duque Gabriel

Working papers from Banque de France

Abstract: This paper argues that the exchange rate regime matters for inflation and economic activity, with substantial benefits arising from a currency peg. At the heart of these benefits lies an increase in credibility that reduces the inflationary bias once central banks commit to peg their currency to a credible anchor. Using an open economy model, we provide a credibility estimate for 170 economies for 1950-2019 which aligns with other central bank independence measures. We document that committing to a peg persistently lowers inflation and its volatility while increasing real economic growth. Less credible countries benefit more from fixing the exchange rate.

Keywords: Exchange Rate Regimes; Monetary Policy; Interest Rates; Inflation (search for similar items in EconPapers)
JEL-codes: E31 E42 E52 F41 F42 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:974

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