DP503 | Monetary Accommodation, Exchange Rate Regimes and Inflation Persistence

Publication Date

01/01/1991

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Abstract

This paper investigates the relation between the dynamics of inflation and international monetary and exchange rate regimes in the industrial economies. It demonstrates that fixed exchange rate regimes like the international gold standard and the Bretton Woods gold dollar standard appear to be associated with negligible persistence of inflation, while regimes of managed exchange rates are associated with very high persistence of inflation. The interwar period is associated with persistent deflation, and the more recent period of managed floating is associated with persistent inflation. The paper uses an overlapping contracts model to propose that the higher persistence of inflation is the result of a higher monetary and exchange rate accommodation of price changes in flexible exchange rate regimes. The evidence does not seem to contradict this hypothesis. The results highlight the importance of the effects of monetary regimes on expectations and the behaviour of wage- and price-setters.