When pegging is a commitment device: Revisiting conventional wisdom about currency crises

Abstract

Could a less conservative central bank, that is, one with a smaller aversion to inflation, be more likely to withstand pressure on its currency peg? Traditional currency-crisis models provide an unambiguous answer: No. We argue that this answer stems from the models' narrow focus on how a central bank's resistance to private-sector pressure affects output and inflation in the short run. The answer may reverse if pegging is a commitment device, serving to address domestic credibility issues in the long run by transferring the conduct of monetary policy abroad. As a less conservative central bank stands to benefit more from such a transfer, it should find a peg more valuable.