Reinhart, Carmen and Reinhart, Vincent (2003): Twin fallacies about exchange rate policy in emerging markets. Published in: Moneda y Crédito , Vol. 216, (2003): pp. 11-29.
Download (731kB) | Preview
Two assertions about exchange rate regimes circulate with some frequency in policy circles. The first, the hypothesis of the excluded middle, holds that authorities must either choose perfectly floating exchange rates (preferably anchored by an inflation target for the central bank) or a hard (preferably irrevocable) peg. The second, seemingly unrelated, argues that the inability of emerging market economies to exercise monetary independence owes to the severe mistrust that they are perceived with by global investors because of the economic failures of prior governments. This paper argues that the theories of the excluded middle and original sin are twin and related fallacies that are contrary to theory and evidence. This paper will provide a model in which the government can choose policies consistent with either a pure float anchored by a constant money stock or a pure peg but, under certain circumstances, fail to find exchange rate stability at either corner. The problem is that the potential for regime change implies that the current government’s successors may behave less admirably, which will weigh on investors’ current behavior. The difficulties imparted by this expectation channel in an otherwise standard model of optimizing agents endowed with rational expectations shows both why looking back to explain credibility problems is looking the wrong way and why the excluded middle is, in fact, so crowded
|Item Type:||MPRA Paper|
|Original Title:||Twin fallacies about exchange rate policy in emerging markets|
|Keywords:||exchange rate policy fixed bipolar view foreign currency debt credibility|
|Subjects:||F - International Economics > F3 - International Finance > F30 - General
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
F - International Economics > F3 - International Finance > F31 - Foreign Exchange
|Depositing User:||Carmen Reinhart|
|Date Deposited:||09. Mar 2009 18:38|
|Last Modified:||13. Feb 2013 01:46|
Calvo, Guillermo A., On the Time Consistency of Optimal Policy in a Monetary Economy, Econometrica, Nov. 1978, v. 46, iss. 6, pp. 1411-28
Calvo, Guillermo A., On Models of Money and Perfect Foresight, International Economic Review, Feb. 1979, v. 20, iss. 1, pp. 83-103.
Calvo, Guillermo A. Reinhart and Carmen M. Fear of Floating, Quarterly Journal of Economics, May 2002, v. 117, iss. 2, pp. 379-408.
Eichengreen, Barry and Ricardo Hausmann, Exchange Rates and Financial Fragility, in New Challenges for Monetary Policy, Proceedings of a Symposium Sponsored by the Federal Reserve Bank of Kansas City, 1999, pp. 329-368.
Fischer, Stanley, Exchange Rate Regimes: Is the Bipolar View Correct? Finance and Development, June 2001, v. 38, iss. 2, pp. 18-21.
Frankel, Jeffrey, Sergio Schmukler, and Luis Servén, “Verifiability and the Vanishing Intermediate Exchange Rate Regime,” Brookings Trade Forum, 2000, pp. 49-108.
Hausmann, Ricardo, Unrewarded Good Fiscal Behavior: The Role of Debt Structure, working paper, Harvard University, 2002.
Kaminsky, Graciela, Carmen Reinhart, and Carlos Végh, Two Centuries of Financial Market Contagion, working paper, International Monetary Fund, 2002.
Krugman, Paul, A Model of Balance-of-Payments Crises, Journal of Money, Credit, and Banking, Aug. 1979, v. 11, iss. 3, pp. 311-25.
Mussa, Michael, A Model of Exchange Rate Dynamics, Journal of Political Economy, Feb. 1982, v. 90, iss. 1, pp. 74-104.
Obstfeld, Maurice and Kenneth Rogoff, Exchange Rate Dynamics Redux, Journal of Political Economy, June 1995, v. 103, iss. 3, pp. 624-60.
Obstfeld, Maurice and Kenneth Rogoff, Foundations of International Macroeconomics, MIT Press, 1996.
Persson, Torsten and Guido Tabellini, Monetary and Fiscal Policy (Volume2: Politics), MIT Press, 1994.
Reinhart, Carmen M., Mirage of Floating Exchange Rates, American Economic Review, May 2000, v. 90, iss. 2, pp. 65-70 Summers, Lawrence H., International Financial Crises: Causes, Prevention, and Cures, American Economic Review, May 2000, v. 90, iss. 2, pp. 1-16.
Wills, Garry, Saint Augustine, Viking Press (Penguin Lives), 1999.
Wilson, Charles A., Anticipated Shocks and Exchange Rate Dynamics, Journal of Political Economy, June 1979, v. 87, iss. 3, pp. 639-47