Year: 1996
Author: Spahn, Heinz-Peter
Credit and Capital Markets – Kredit und Kapital, Vol. 29 (1996), Iss. 4 : pp. 511–527
Abstract
Credibility, Time Inconsistency and Interest Rate Differences in a Fixed Exchange Rate System
The Barro-Gordon model can be applied to an open economy. If the welfare function of the economic policy agent exhibits a preference for the target of employment, the promise to keep a fixed exchange rate is not credible as a devaluation enhances employment in case of lagging exchange rate expectations. In anticipation of a cheating of national policy makers devaluation expectations emerge causing interest differences between financial assets denominated in different currencies. Accordingly, economic policy has to choose between two unfavourable alternatives: to defend the fixed exchange rate by means of high interest rates causing employment losses or to execute an already expected devaluation aggravating the risk of inflation. Interest rate differences and currency crises in the EMS can be conceived as partly failed attempts to base economic and monetary policies on long-term targets and commitments.
Journal Article Details
Publisher Name: Global Science Press
Language: Multiple languages
DOI: https://doi.org/10.3790/ccm.29.4.511
Credit and Capital Markets – Kredit und Kapital, Vol. 29 (1996), Iss. 4 : pp. 511–527
Published online: 1996-04
AMS Subject Headings: Duncker & Humblot
Copyright: COPYRIGHT: © Global Science Press
Pages: 17
Author Details
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