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, Revised in December 2006
NBER Program(s):International Finance and Macroeconomics

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

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w11652

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. citation courtesy of

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
Alesina and Wagner w9809 Choosing (and reneging on) exchange rate regimes
Eichengreen, Rose, and Wyplosz w4898 Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System
Calvo and Mishkin w9808 The Mirage of Exchange Rate Regimes for Emerging Market Countries
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

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

Contact Us