Abstract

We find that strong (weak) fiscal policy credibility leads to a significant exchange rate appreciation (depreciation), reduces (increases) inflation and lowers inflation expectations. Evidence based on the counterfactual VAR model shows that improvements in fiscal policy credibility neutralise the transmission of exchange rate depreciation shocks to inflation and inflation expectations especially in the high inflation regime. Thus, we conclude that strengthening fiscal policy credibility is needed to reduce the exchange rate pass-through to inflation and inflation expectations and this assists monetary policy authorities in achieving the price stability mandate.

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