ON THE CREDIBILITY OF ALTERNATIVE EXCHANGE-RATE REGIMES

Most anti-inflation plans have used a nominal exchange rate anchor eve n though many other variables can serve this role. The conventional wi sdom is that an exchange rate anchor imposes more macroeconomic discip line than other anchors, though theory does not yet provide any clear reason why this is so. We explain the link between an exchange rate an chor and discipline with a model that assumes that the public can moni tor the nominal exchange rate more easily than it can the other variab les. In our model, a Barro-Gordon of incomplete information with imper fect monitoring, we show that serious stabilizers prefer more visible anchors, such as the nominal exchange rate. We also show that in some circumstances serious stabilizers will choose to fix the exchange rate even when fixed exchange rates have some costs, such as diminished ca pabilities to respond to external shocks. (C) 1997 Elsevier Science B. V.