Abstract
The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Few would dispute the view that money matters, but those in the economics profession who study monetary policy have chosen to concentrate on issues surrounding the design of monetary policy.
This paper surveys three kinds of reforms that address the problem of price stability. They are, in no particular order, the sort of exchange rate regime, the degree of independence accorded to the central bank, and the option of joining together with other countries in a currency union.
Choosing an exchange rate regime involves determining the degree of independence desired by a country in the area of monetary policy. There have been relatively few examples of strictly fixed or flexible exchange rate systems in recent memory. Indeed, the exchange rate regime chosen seems to depend upon whether it appears politically, as opposed to economically, advantageous for a particular government to follow the monetary policy of another country. The choice of an exchange rate regime also reflects the desire of governments to achieve credibility in the application of policies.
The issue of central bank independence is complex as it involves perceived notions of independence as opposed to the degree of legislative independence provided to a central bank to achieve a single goal or a multitude of goals. A survey of existing empirical evidence points out that simple correlations of legislative independence and inflation performance are quite sensitive to economists’ and others’ perceptions of what the legislative authorities intended central banks to accomplish in the application of monetary policy.
Currency unions represent an extreme form perhaps of the policy of tying one’s hands together in monetary policy. Few countries achieve the preconditions for optimal currency unions and so the paper argues that, once again, when purely economic explanations do not justify such an arrangement, political motives dominate. The paper briefly reviews some historical examples of currency unions and points out the political motives and pitfalls of exiting proposals for monetary union in Europe. The choice of monetary regime rests with political economy considerations that involve questions of how independent a country wishes to be from shocks emanating from the rest of the world and how much weight politicians attach to influencing economic conditions in their own country.