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Credibility of Policies versus Credibility of Policymakers

Allan Drazen () and Paul Masson ()

No 4448, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Standard models of policy credibility. defined as the expectation that an announced policy will be carried out. emphasize the preferences of the policymaker (his "type") and the role of policies in signaling type. Whether a policy is carried out. however. should also reflect the state of the economy. so that even a "tough" policymaker may renege on an announced policy in adverse circumstances. We investigate this alternative notion of credibility, using an "escape clause" model of devaluation. 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 the process driving unemployment, following a tough policy in a given period may lower rather than raise the credibility of a no-devaluation pledge in subsequent periods. in contrast to the results in the earlier literature. We test this implication on EMS interest rates and find support for our hypothesis.

JEL-codes: E60 F33 (search for similar items in EconPapers)
Date: 1993-09
Note: IFM
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Published as Quarterly Journal of Economics, vol.109, no.3, August 1994.

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