Discussion Paper Details

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Title: Monetary Policies for Developing Countries: The Role of Institutional Quality

Author(s): Haizhou Huang and Shang-Jin Wei

Publication Date: February 2005

Keyword(s): conservative central banker, corruption, currency board, dollarization, inflation targeting, institutional quality and monetary policy

Programme Area(s): Institutions and Economic Performance and International Macroeconomics

Abstract: Weak public institutions, including high levels of corruption, characterize many developing countries. With a simple model, we demonstrate that institutional quality has important implications for the design of monetary policies and can produce several departures from the conventional wisdom. We find that a pegged exchange rate or dollarization, while sometimes prescribed as a solution to the problem of a lack of credibility, is typically not appropriate in developing countries with poor institutions. Such an arrangement is inferior to an optimal inflation targeting, or a Rogoff-style central banker, whose optimal degree of conservatism is proportional to the quality of institutions. Furthermore, our results cast doubt on the notion that a low inflationary target or a currency board can be used as an instrument to induce governments to strengthen quality of public institutions.

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Bibliographic Reference

Huang, H and Wei, S. 2005. 'Monetary Policies for Developing Countries: The Role of Institutional Quality'. London, Centre for Economic Policy Research.