## Bad Dreams Under Alternative Anchors: Are the Consequences Different?

_IMF Working Papers, January 1, 2000_

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## Bibliographic details
- Authors: Leonardo Auernheimer, Susan M George
- Published: January 1, 2000
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451843835.001

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### Summary
- Using a simple model, the paper shows how a strict monetary rule exhibits characteristics similar to those of an exchange rate anchor, in terms of a lack of robustness in the presence of adverse expectations (“bad dreams”).
- An anticipated devaluation under an exchange rate rule leads to contractionary effects.
- An anticipated increase in the money stock under a monetary rule, though initially expansionary, becomes contractionary when these expectations are not validated.
- The evidence suggests that much of the criticism of an exchange rate anchor implicitly considers not another rule but rather, discretion as the alternative.

### Key findings
- Strict monetary rules can mimic the vulnerabilities of exchange rate anchors when agents form adverse expectations.
- Anticipated policy actions can have reversed effects if expectations are disappointed:
  - Anticipated devaluation (exchange rate rule) → contractionary effects.
  - Anticipated increase in money stock (monetary rule) → initially expansionary but becomes contractionary if not realized.
- The paper emphasizes the role of expectations in determining the real effects of alternative nominal anchors.

### Policy implications
- Policymakers should account for expectation-driven channels when choosing between exchange rate anchors and strict monetary rules.
- Critiques of exchange rate anchors should clarify whether the intended alternative is another rule (e.g., a monetary rule) or discretionary policy, since outcomes differ when discretion is the implicit comparator.
- Robustness to adverse expectations is a key criterion in assessing nominal anchors.

### Subjects and keywords
- Subjects: Exchange rate adjustments, Exchange rates, Financial services, Foreign exchange, Monetary base, Money, Real exchange rates, Real interest rates
- Keywords: money stock, real interest rate, WP

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/bad-dreams-under-alternative-anchors-are-the-consequences-different-3423_