DP390 | Exchange Rate Regimes and the Persistence of Inflation

Publication Date

01/03/1990

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Abstract

This paper investigates the relation between the dynamics of inflation and exchange-rate regimes. It demonstrates that fixed exchange-rate regimes such as the international gold standard and the Bretton Woods gold-dollar standard appear to be associated with negligible persistence of inflation in the industrial economies, while regimes of managed exchange rates are associated with very high persistence of inflation: the interwar period is associated with persistent deflation, the more recent period of managed floating with persistent inflation.The paper uses an overlapping contracts model of inflation to propose that the persistence of higher inflation in managed exchangerate regimes is a result of the accommodation of inflationdifferentials by exchange-rate policy. The evidence does not seemto contradict this hypothesis.