Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/264690 
Year of Publication: 
2005
Series/Report no.: 
Working Paper No. 98
Publisher: 
Oesterreichische Nationalbank (OeNB), Vienna
Abstract: 
We show that the credibility gain from permanently committing to a fixed exchange rate by joining the European Monetary Union can outweigh the loss from giving up independent monetary policy if the domestic monetary authority does not enjoy full credibility. Using a DSGE model, this paper shows that when the central bank enjoys only limited credibility a pegged exchange rate regime yields a lower loss compared to an inflation targeting policy, even if this policy ranking would be reversed in a full-credibility environment. There exists an initial stock of credibility that must be achieved for a policy-maker to adopt inflation targeting over a strict exchange rate targeting regime. Full credibility is not a precondition, but exposure to foreign and financial shocks and high steady state inflation make joining the EMU relatively more attractive for a given level of credibility. The theoretical results are consistent with empirical evidence we provide on the relationship between credibility and monetary regimes using a Bank of England survey of 81 central banks.
Subjects: 
Inflation targeting
Credibilty
Open Economy
Exchange Rate Regimes
Monetary Policy
JEL: 
E52
E31
F02
F41
Document Type: 
Working Paper

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