Fear of Floating and Social Welfare
by Demosthenes N. Tambakis
Faculty of Economics and Pembroke College, University of Cambridge
This paper studies the welfare implications of financial stability
and inflation stabilization as distinct monetary policy
objectives. Introducing asymmetric aversion to exchange rate
depreciation in the Barro-Gordon model mitigates inflation
bias due to credibility problems. The net welfare impact of
fear of floating depends on the economy's recent track record,
the credibility of monetary policy, and the central bank's discount
factor. It is shown that fear of floating is more appropriate
for financially fragile developing countries with imperfectly
credible monetary policy than for advanced economies.
JEL Codes: E52, E58, F33.
(PDF, 22 pages 318 kb)