Pegged Exchange Rate Regimes—A Trap? |
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Authors: | JOSHUA AIZENMAN REUVEN GLICK† |
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Institution: | Joshua Aizenman;is a Professor of Economics, Department of Economics, University of California, Santa Cruz (E-mail:) . Reuven Glick;is Group Vice President, International Research, Economic Research Department, Federal Reserve Bank of San Francisco (E-mail:). |
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Abstract: | We analyze the role of an exchange rate peg as a commitment mechanism to achieve inflation stability when multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative regime not only in order to mitigate inflation bias from time inconsistency but also to avoid high inflation equilibria. In these circumstances, using a pegged exchange rate as an anti-inflation commitment device can create a "trap" whereby the regime initially confers gains in anti-inflation credibility but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy. |
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Keywords: | F15 F31 F43 |
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