Self-fulfilling Currency Crises and Central Bank Independence

We develop a model of a fixed exchange rate peg arrangement derived from the Barro–Gordon model of rules versus discretion. It is shown that the fixed peg is vulnerable to self-fulfilling currency crises in which the unemployment rate increases, the credibility of the rule decreases, but, paradoxically, the reputation of the policy-maker improves. Delegating monetary policy to an independent central banker does not prevent this type of crisis from arising, and can even make it more costly.
JEL Classification: F 3; F 4