Fiscal Discipline and Exchange Rate Regimes : Evidence From the Caribbean

Author/Editor:

Rupa Duttagupta ; Guillermo Tolosa

Publication Date:

May 1, 2006

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper assesses the nature of fiscal discipline under alternative exchange rate regimes. First, it shows in a simple theoretical framework that fiscal agencies under a currency union with a fixed exchange rate can have the largest incentive to overspend or "free-ride" (compared to those under other exchange rate regimes) owing to their ability to spread the costs of overspending in terms of the inflation tax across both time-given the fixed exchange rate-and space-given the currency union. In contrast, such free-riding behavior does not arise under flexible regimes owing to the immediate inflationary impact of spending. Next, empirically, it shows that fiscal stances in countries with fixed pegs and currency unions regime demonstrate greater free-riding behavior than countries with more flexible regimes in 15 Caribbean countries during 1983-2004.

Series:

Working Paper No. 06/119

Subject:

English

Publication Date:

May 1, 2006

ISBN/ISSN:

9781451863796/1018-5941

Stock No:

WPIEA2006119

Format:

Paper

Pages:

37

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