Fiscal Discipline and Exchange Rate Regimes

Matthew Canzoneri, Robert Cumby () and Behzad Diba

No 1899, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper explores the implications of a new theory of price determination (due to Leeper, Woodford and Sims) for the maintenance of various exchange rate systems – crawling pegs, fixed pegs, and common currency areas. It shows that deeper monetary integration requires more fiscal discipline, especially if price stability is an objective; these monetary arrangements cannot be achieved by monetary policy alone, as conventional wisdom would seem to suggest. A particularly striking result is that a currency peg is simply not sustainable if fiscal surpluses are determined by an exogenous political process; maintenance of a fixed currency peg requires the government to guarantee fiscal solvency for any equilibrium sequence of prices (which Woodford calls a Ricardian Regime). Interestingly, the debt and deficit constraints that were written into the Maastricht Treaty, and will continue in the Stability Pact after EMU, are examples of the fiscal discipline that is required.

Keywords: Exchange Rate Regimes; Fiscal Discipline; price determination (search for similar items in EconPapers)
JEL-codes: E31 F33 F41 (search for similar items in EconPapers)
Date: 1998-05
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Citations: View citations in EconPapers (13)

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