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Fiscal Discipline and Exchange Rate Regimes: Evidence From the Caribbean
Author: Rupa Duttagupta and Mr. Guillermo Tolosa
Series:
IMF Working Papers
Volume/Issue:
Volume 2006: Issue 119
Language:
English
Publication Date:
01 May 2006
DOI:
https://doi.org/10.5089/9781451863796.001
ISBN:
9781451863796
ISSN:
1018-5941
Pages:
37
Keywords:
WP; exchange rate; central bank; Fiscal policy; currency unions; exchange rates; FPCU regime; ECCU country; utility function; inflation cost; dislike inflation; aggregate government budget constraint; budget constraint; exchange rate case; ECCU member; money growth; ECCU member country; common currency; Exchange rate arrangements; Conventional peg; Fiscal stance; Monetary unions; Caribbean
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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This paper assesses the nature of fiscal discipline under alternative exchange rate regimes. First, it shows in a simple theoretical framework that fiscal agencies under a currency union with a fixed exchange rate can have the largest incentive to overspend or "free-ride" (compared to those under other exchange rate regimes) owing to their ability to spread the costs of overspending in terms of the inflation tax across both time-given the fixed exchange rate-and space-given the currency union. In contrast, such free-riding behavior does not arise under flexible regimes owing to the immediate inflationary impact of spending. Next, empirically, it shows that fiscal stances in countries with fixed pegs and currency unions regime demonstrate greater free-riding behavior than countries with more flexible regimes in 15 Caribbean countries during 1983-2004.
Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund