Monetary discipline and inflation in developing countries: the role of the exchange rate regime

Adherence to a pegged exchange rate regime has the potentialto affect inflation in two ways: by instilling monetary disciplineand by altering the relationship between money and prices, becauseshocks to the money stock are absorbed partly by changes inthe balance of payments. Although the latter is a disequilibriumphenomenon (if balance of payments deficits are unsustainablein the long run), it might still be important in the mediumterm. Evidence on the relative importance and magnitude of thetwo effects is presented, using cross-sectional macroeconomicdata from 80 LDCs. Both effects are found to be significant.