Working Paper: NBER ID: w4504
Authors: Lars E. O. Svensson
Abstract: The paper discusses what we have learned from last year's currency crises in ERM and the Nordic countries about fixed exchange rates as a means to achieve price stability. After discussing the explanations for the crises, the paper concludes that fixed exchange rates are not a shortcut to price stability. Monetary stability and credibility have to be built at home and cannot easily be imported from abroad. Fixed exchange rates are more fragile and difficult to maintain than previously thought. They may even be in conflict with price stability, by inducing a procyclical destabilizing monetary policy, and by inducing an inflation bias. Building monetary credibility is even more important with flexible exchange rates.
Keywords: fixed exchange rates; price stability; currency crises; monetary policy
JEL Codes: E42; E52; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher domestic inflation (E31) | real exchange rate appreciation (F31) |
| real exchange rate appreciation (F31) | reduced demand for domestic goods (F69) |
| reduced demand for domestic goods (F69) | recession (E32) |
| recession (E32) | lower inflation (E31) |
| pegging the exchange rate (F31) | domestic monetary policy focused on maintaining the peg (E63) |
| domestic monetary policy focused on maintaining the peg (E63) | implicit or explicit coordination of domestic and foreign monetary policy (F42) |