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September 2007 issue
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Gerlach
Locarno
Elizalde, Repullo
Pagratis
Bech, Hobijn
Tambakis
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Fear of Floating and Social Welfare

by Demosthenes N. Tambakis
Faculty of Economics and Pembroke College, University of Cambridge

Abstract

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.

 
Full article (PDF, 22 pages 318 kb)