NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Pegged Exchange Rate Regimes -- A Trap?

Joshua Aizenman, Reuven Glick

NBER Working Paper No. 11652
Issued in October 2005
NBER Program(s):   IFM

This paper studies the empirical and theoretical association between the duration of a pegged exchange rate and the cost experienced upon exiting the regime. We confirm empirically that exits from pegged exchange rate regimes during the past two decades have often been accompanied by crises, the cost of which increases with the duration of the peg before the crisis. We explain these observations in a framework in which the exchange rate peg is used as a commitment mechanism to achieve inflation stability, but multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative not only in order to mitigate the inflation bias from the well-known time inconsistency problem, but also to steer the economy away from the high inflation equilibria. These gains, however, come at a cost in the form of the monetary authority’s lesser responsiveness to output shocks. 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. We also show that the more conservative is the regime in place and the larger is the cost of regime change, the longer will be the average spell of the fixed exchange rate regime, and the greater the output contraction at the time of a regime change.

download in pdf format
   (215 K)

email paper

This paper is available as PDF (215 K) or via email.

This paper was revised on December 28, 2006

Machine-readable bibliographic record - MARC, RIS, BibTeX

Published: Joshua Aizenman & Reuven Glick, 2008. "Pegged Exchange Rate Regimes-A Trap?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 817-835, 06.

Users who downloaded this paper also downloaded these:
Klein and Shambaugh w12729 The Nature of Exchange Rate Regimes
Aizenman and Glick w13902 Sterilization, Monetary Policy, and Global Financial Integration
Aizenman and Lee w12718 Financial Versus Monetary Mercantilism-Long-run View of Large International Reserves Hoarding
Garber The Collapse of the Bretton Woods Fixed Exchange Rate System
Gali and Monacelli w8905 Monetary Policy and Exchange Rate Volatility in a Small Open Economy
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us