Currency Boards, Credibility, and Macroeconomic Behavior

From Recession to Growth in Transition Economies

Author: Mr. Amadou N Sy and Luis Rivera-Batiz

Currency boards operate differently from standard pegs. The former exhibit greater currency stability and lower transaction costs, inflation, and nominal interest rates, but are limited in their use of devaluation. We extend Drazen and Masson's (1994) signaling model to consider the choice between currency board arrangements and standard pegs. The model shows that currency boards' effectiveness hinges on their credibility properties and that they can improve welfare even with high unemployment persistence. By reducing expected inflation and the negative employment effect arising from expected but unrealized inflation, currency boards can produce less unemployment than peg regimes that abstain from devaluation.

Volume/Issue: Volume 2000 Issue 097

Publication date: June 2000

ISBN: 9781451852011

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Topics covered in this book

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Business and Economics , Inflation , Labor , Money and Monetary Policy , WP , currency board , Hong Kong dollar , exchange rate , Singapore dollar , Thai baht , Credibility , Currency Crisis , Fixed Exchange Rate , money market , currency regime choice , currency board structures , currency market bid-Ask , regime choice , currency market spread , Hong Kong currency board regime , currency board peg , inflation stability , Currency boards , Inflation , Exchange rate arrangements , Currencies , Unemployment , East Asia , Baltics

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Summary

Currency boards operate differently from standard pegs. The former exhibit greater currency stability and lower transaction costs, inflation, and nominal interest rates, but are limited in their use of devaluation. We extend Drazen and Masson’s (1994) signaling model to consider the choice between currency board arrangements and standard pegs. The model shows that currency boards’ effectiveness hinges on their credibility properties and that they can improve welfare even with high unemployment persistence. By reducing expected inflation and the negative employment effect arising from expected but unrealized inflation, currency boards can produce less unemployment than peg regimes that abstain from devaluation.