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Importing Credibility Through Exchange Pegging

Berthold Herrendorf ()

The Warwick Economics Research Paper Series (TWERPS) from University of Warwick, Department of Economics

Abstract: This paper employs an optimal taxation framework in order to study the credibility of monetary policy-making in an open economy. Since inflation is, in part, uncontrollable due to stochastic disturbances, the authority's actions cannot be monitored perfectly when exchange rate floats, thus implying that the reputational forces may become ineffective. In contrast, pegging the nominal exchange rate to a low-inflation currency allows perfect monitoring, because the exchange rate is, in principle, controllable. For this reason, exchange rate pegging may import credibility and result in the best reputational equilibrium, even though the authority retains the discretion to devalue unexpectedly.

Keywords: Credibility; Exchange Rate Pegging; Incomplete Information; Inflation Tax; Reputation (search for similar items in EconPapers)
JEL-codes: E52 E61 F33 (search for similar items in EconPapers)
Pages: 12 pages
Date: 1996
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Persistent link: https://EconPapers.repec.org/RePEc:wrk:warwec:446

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