Fiscal policies, devaluations and exchange rate regimes": a comment

and draws out lessons for the design of such programmes in small open economies. Programmes relying on government revenue increases are judged to be less likely to succeed than those based on expenditure reductions. The contribution which devaluation in the initial stages of such a programme can make is also emphasised, but only in the context of a regime with established anti-inflationary credibility.

The Economic Journal, 2001

This paper examines the implications of a new theory of price determination (due to Leeper, Sims, and Woodford) for the maintenance of various exchange rate systems and common currency areas. It shows that deeper monetary integration requires the fiscal discipline of what Woodford calls a Ricardian regime; that is, the government must guarantee fiscal solvency for any sequence of prices or exchange rates. Monetary policy alone can control the expected rate of inflation (or depreciation), but in Non-Ricardian regimes monetary policy can not control the variability of prices (or exchange rates) in countries where seigniorage revenues are negligible. Particularly striking results are that a currency peg is simply not credible unless fiscal policy has the discipline of a Ricardian regime, and a common currency area is not viable if fiscal policy in two (or more) of the countries in the union is Non-Ricardian. Interestingly, the constraints written into the Maastricht Treaty (and continuing in the Stability and Growth Pact) are sufficient conditions for a Ricardian regime. ___________________________ *We would like to thank (without implicating) Martin Eichenbaum, Kenneth Rogoff, Mike Wickens and three referees for helpful suggestions.

2009

... [email protected] ... no possibility to devalue, the restoration of competitiveness requires a continuing reduction in prices and costs in Ireland relative to other Eurozone countries, the more so given Ireland's exceptional exposure to the appreciating exchange rate (Lane (2009 ...

Wisselkoersen in een Veranderende Wereld, Preadvies van de Vereniging voor de Staathuishoudkunde, Stenfert Kroese, Leiden, Antwerpen, 1986, pp. 99-117, 1986

The paper first reviews the budget identities of the fiscal and monetary authorities and the solvency constraint or present value budget constraint of the consolidated public sector, for closed and open economies. It then discusses the new conventional wisdom concerning the fiscal roots of inflation and the budgetary prerequisites for generating and stopping hyperinflation. The popular rational expectations "Unpleasant Monetarist Arithmetic" model of Sargent and Wallace has ambiguous inflation implications from an increase in the fundamental deficit and is incapable of generating hyperinflatior. The only runaway, explosive or unstable behavior it can exhibit is "hyperdeflation"! In the open economy, the need to maintain a managed exchange rate regime does not impose any constraint on the growth rate of domestic credit, arising through the government's need to remain solvent. Obstfeld's proposition to the contrary is due to the omission of government bonds and borrowing. There is not yet any "deep structural" theory justifying the (exogenous) lower bounds on the stock of foreign exchange reserves characteristic of the collapsing exchange rate literature. Absent such a theory of "international liquidity," one cannot model satisfactorily a foreign exchange crisis that is not at the same time a government solvency crisis. Given such a lower bound, the existence or absence of a pecuniary opportunity cost to holding reserves is shown to condition the fiscal and financial actions consistent with prolonged survival of the managed exchange rate regime.

Policy Research Working Papers

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

2018

We propose an integrated fiscal and monetary approach to economic stabilisation policy in small open financially integrated economies (SOFIEs), using fiscal policy to achieve external balance at a targeted exchange rate. This approach overcomes the conundrum of the conventional Mundell-Fleming view in today's world of international financial integration, where capital controls do not insulate the small domestic economy, and where local authorities cannot be indifferent to the volatility of the exchange rate of local currency, and the potential harm to savings, investment, capital flight and domestic financial stability. In today's world, the standard prescription of flexible exchange rates and independent monetary control targeting inflation presents challenges with which SOFIEs have struggled, with little success. We describe the framework for an alternative which suits the circumstances of SOFIEs.

There is convincing empirical evidence that the cycle for exchange-rate-based disinflation in high-inflation Latin American economies typically begins with expansion and ends in recession - a surprising pattern. The authors explore whether a similar cycle can be observed in exchange-rate-based disinflation in low-inflation economies. They draw on empirical evidence from stabilizaton programs in three European countries in the early 1980s: in Denmark (1982), Ireland (1982), and France (1983). In these programs, the authorities fixed the central parity of the exchange rate band against the European currency unit (ECU). This represented a break from previous years when this rate was often realigned to accommodate inflation. They find that the Irish and French programs followed the more traditional pattern. In the initial phase, there was a recession accompanied by a continuous, gradual reduction in inflation - followed by a second, more expansionary, phase. The initial recession was at...

PSN: Exchange Rates & Currency (Comparative) (Topic), 2017

We propose an integrated fiscal and monetary approach to economic stabilisation policy in small open financially integrated economies (SOFIE’s), using fiscal policy to achieve external balance at a targeted exchange rate. This approach overcomes the conundrum of the conventional Mundell-Fleming view, in today’s world of international financial integration, where capital controls do not insulate the small domestic economy, and where local authorities cannot be indifferent to the volatility of the exchange rate of local currency, and the potential harm to savings, investment, capital flight and domestic financial stability. In today’s world, the standard prescription of flexible exchange rates and independent monetary control targeting inflation presents challenges with which SOFIE’s have struggled, with little success. We describe the framework for an alternative which suits the circumstances of SOFIE’s.

1986

The paper first reviews the budget identities of the fiscal and monetary authorities and the solvency constraint or present value budget-constraint of the consolidated public sector, for closed and open economies. It then discusses the new conventional wisdom concerning the fiscal roots of inflation and the budgetary prerequisites for generating and stopping hyperinflation. The popular rational expectations "Unpleasant Monetarist Arithmetic" model of Sargent and Wallace has ambiguous inflation implications from an increase in the fundamental deficit and is incapable of generating hyperinflatior,. The only runaway, explosive or unstable behavior it can exhibit is "hyperdeflation"! In the open economy, the need to maintain a managed exchange rate regime does not impose any constraint on the growth rate of domestic credit, arising through the government's need to remain solvent. Obstfeld's proposition to the contrary is due to the omission of government bonds and borrowing. There is not yet any "deep structural" theory justifying the (exogenous) lower bounds on the stock of foreign exchange reserves characteristic of the collapsing exchange rate literature. Absent such a theory of "international liquidity," one cannot model satisfactorily a foreign exchange crisis that is not at the same time a government solvency crisis. Given such a lower bound, the existence or absence of a pecuniary opportunity cost to holding reserves is shown to condition the fiscal and financial actions consistent with prolonged survival of the managed exchange rate regime.