Do Fixed Exchange Rates Induce More Fiscal Discipline?

April 1, 2003

Preview Citation

Format: Chicago

Yan M Sun. Do Fixed Exchange Rates Induce More Fiscal Discipline?, (USA: International Monetary Fund, 2003) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Conventional wisdom has held that a fixed exchange rate regime induces more fiscal discipline, but Tornell and Velasco (1995, 1998) argue the opposite. Using a dynamic model with fragmented fiscal policymaking, this paper evaluates the two arguments in a single framework and shows that (1) future punishment against fiscal laxity exists under both fixed and flexible regimes; (2) fiscal authorities have a greater incentive to spend more today under fixed rates than under flexible rates; (3) in the presence of both factors above, fixed rates will induce more fiscal discipline only if the future punishment is sufficiently stronger than under flexible rates; and (4) neither fixed nor flexible rates could resolve the structural distortions caused by fragmented policymaking, and fiscal centralization needs to be undertaken to strengthen fiscal discipline.

Subject: Budget planning and preparation, Conventional peg, Exchange rate arrangements, Government asset and liability management, Inflation

Keywords: Exchange rate, WP

Publication Details

Pages:

31
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2003/078
Stock No:

WPIEA0782003
ISBN:

9781451850123
ISSN:

1018-5941

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