To investigate how a fixed exchange rate affects monetary policy, this paper classifies countries as pegged or nonpegged and examines whether a pegged country must follow the interest rate changes in the base country. Despite recent research which hints that all countries, not just pegged countries, lack monetary freedom, the evidence shows that pegs follow base country interest rates more than nonpegs. This study uses actual behavior, not declared status, for regime classification; expands the sample including base currencies other than the dollar; examines the impact of capital controls, as well as other control variables; considers the time series properties of the data carefully; and uses cointegration and other levels-relationship analysis to provide additional insights.

This paper reviews recent research on central bank independence (CBI). After we have distinguished between independence and conservativeness, the literature on optimal inflation contracts is discussed, followed by research in which the inflationary bias is endogenised. Finally, the various challenges that have been raised against previous empirical findings on CBI are reviewed. We conclude that the negative relationship between CBI and inflation is quite robust. JEL Classification: D72, E58 Helge Berger University of Munich and CESifo Center for Economic Studies Schackstr. 4 80539 Munich Germany e-mail: h.berger@ces.vwl.uni-muenchen.de Jakob de Haan University of Groningen Department of Economics The Netherlands Sylvester C. W. Eijffinger Tilburg University and CEPR CentER The Netherlands 2 1.

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In this paper we examine the nature of currency crises. We ascertain whether the currency crises of the European Monetary System (EMS) were based either on bad fundamentals, or on self-fulfilling market expectations driven by external uncertainty, or a combination of both. In particular, we extent previous work of Jeane and Masson (2000) regarding evaluation of currency crisis. To this end we contribute to the existing literature proposing the use of three different Markov regime-switching models. Our empirical results suggest that the currency crises of the EMS were not due only to market expectations driven by external uncertainty, or ‘sunspots’, but also to fundamental variables that help explain the behaviour of market expectations.

In this paper we identify the main determinants of the exchange rate regimes in Central and Eastern European Countries (CEECs). For this purpose, we use an ordered logit model for the official (de jure) and the actual (de facto) exchangerate classifications. We find that trade openness and concentration, inflation differentials, international reserves stocks, and financial conditions are the main determinants of the exchange rate regimes in CEECs.

Prepared for delivery at the annual meeting of International Studies Association (ISA)

The literature has identified at least five group of explanations to account for the way exchange rate regimes are chosen: i) optimal currency area theory; ii) exchange rates as real and nominal shock absorbers; iii) pegging as a policy crutch in credibility-challenged economies; iv) the impossible trinity constraint in a context of increasing financial globalization; and v) the interplay of exchange rate regimes with balance sheet exposures in financially dollarized economies. Using both a de facto and a de jure regime classification, we test the empirical relevance of these approaches jointly. We find overall empirical support for all but the credibility hypothesis, although the relevance of each of them varies substantially between industrial and non-industrial economies. We show that regime choices, as well as different types of mismatches between actual and reported regimes, can be accurately predicted by a few economic and political factors. Indeed, the link between de facto regimes and its underlying fundamentals has been surprisingly stable over the years, suggesting that the trends typically highlighted in the exchange rate regime debate can be traced back to the evolution of their natural determinants, and that actual policies have been little influenced by the frequent twist and turns of the exchange rate debate.

This paper extends the existing literature on the long run sustainability of monetary unions by analysing the option of monetary disintegration in an optimal stopping framework. We assume that inflation is endogenous and monetary policy is the crucial control variable. Under a particular condition on some parameters, the union goes on forever. Otherwise, we find two critical thresholds: (i) a lower level for domestic inflation and (ii) an upper level for union’s inflation. The optimal time for leaving a union is the first time either domestic inflation goes down the former threshold or union’s inflation goes over the latter threshold.

The monetary policy and exchange rate regime that served Korea well for many years ended in crisis in 1997. The regime that collapsed was characterized by a tightly managed nominal exchange rate and domestic financial markets that were controlled by the government and largely closed to international transactions. The practical question for authorities over the next few years is what monetary and exchange rate regime will best promote the objectives of maintaining economic and financial stability as financial markets are liberalized. Our basic proposal is that the powerful policy tool, interest rate policy, be used to attain a “flexible ” inflation target. Flexibility in this context means that the authorities also care about short-run fluctuations in domestic output and employment. The less powerful policy tool, sterilized intervention in the foreign exchange market, would be used to limit day to day changes in exchange rates. We argue that the government should continue to be an important participant in the foreign exchange market but not attempt to establish a level for the exchange rate. Our proposal will involve intervention that is triggered by exchange rate volatility but