On the exchange rate as a nominal anchor: The rise and fall of the credibility hypothesis

The credibility hypothesis, which was used to support the use of a pegged e xchange rare arrangement as a nominal anchor mechanism, is based on restric tive analytical foundations that circumscribe its real world applicability. While all pegged exchange rate arrangements are subject to circumstances t hat can undermine the sustainability of the peg, exchange rate nominal anch or pegs are especially fragile because such arrangements introduce problems that are endogenous to that particular type of regime. The East Asian cris is is used to demonstrate the fragility of exchange rate nominal anchor peg s, while the case of Australia demonstrates how a floating currency escaped the contagion of the East Asian crisis.