By Holger C. Wolf, Atish R. Ghosh, Helge Berger, Anne-Marie Gulde
An authoritative research that employs monetary concept, cross-country empirical comparability, and case experiences to investigate the impact of foreign money forums on inflation, output development and macroeconomic functionality.
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Extra info for Currency Boards in Retrospect and Prospect (CESifo Book Series)
For a soft peg to be optimal, the polynomial ZðrÞ must have a solution Zðr Ã Þ 0 < r Ã < 1; heuristically, this requires that Zð0Þ < 0 and Zð1Þ > 0, which implies25 A2y2y2 A 2 y 2 sh2 1 þ Ay 1 þ Ay 2 þ se2 < 2 < ð1 þ Ay 2 Þse2 þ A 2 y 2 ð1 þ Ay 2 Þ 2 y 2 : ð29Þ The ﬁrst part of the condition implies that unless the real shocks to the economy are sufﬁciently large relative to either the monetary shocks or the policy credibility problem, a hard peg (with little scope for exit) is optimal. The second part of the condition indicates that if real shocks are too large (again in relation to the monetary shocks or the policy credibility problem), the country will be constantly exiting the peg and should simply adopt a ﬂoat instead.
Compared to a ﬂoating exchange rate regime, the most obvious difference lies in the commitment to keep the nominal parity ﬁxed. Furthermore, a ﬂoating exchange rate system speciﬁes the exchange rate regime but does not impose a monetary regime: the central bank can still decide on its monetary policy, be it a rule—such as an interest rate rule, a base money target, or an inﬂation target—or be it pure discretion. Under a currency board, by contrast, monetary policy is fully subordinated to the exchange rate commitment; by the rules of the regime, monetary growth is largely determined by balance of payments ﬂows.
It follows that the welfare loss is lower under the ﬁxed exchange rate regime: L Peg ¼ Ay 2 < ð1 þ Ay 2 ÞAy 2 ¼ L Flt : Using the exchange rate as a nominal anchor thus provides a precommitment device, which allows the central bank to avoid the welfare cost associated with the central bank’s inability to commit to low inﬂation. Drawing these cases together, we observe that in general a ﬂoating regime is better when the economy is subject to large real shocks; a ﬁxed exchange rate is preferable when either monetary shocks or policy credibility problems dominate.