Words vs. Deeds: What Really Matters?

IMF Working Papers, May 1, 2011

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Revisits the link between the nominal exchange rate regime and inflation for 145 emerging market and developing countries (EMDCs) over the period 1980-2010.
Central hypothesis: a de jure peg without a corresponding de facto peg yields little value; likewise, de facto pegs lacking a corresponding de jure peg reap few of the low inflation benefits associated with pegging the exchange rate.
Empirical result: pegged exchange rates are associated with significantly lower inflation in EMDCs than flexible exchange rates.
Magnitude and nuance: the low-inflation effect is much stronger for de facto pegs that are matched by de jure pegs than for de facto pegs that are not matched by de jure pegs.
Conclusion: both deeds (de facto behavior) and words (de jure declarations) matter for anchoring expectations and delivering low inflation.

Sample: 145 emerging market and developing countries (EMDCs).
Time period: 1980-2010.
Novel data use: exploits a dataset containing both de jure and de facto exchange rate regime classifications to test the role of concordance between declared and actual regimes.

Credible nominal anchors require both a declared (de jure) regime and consistent policy behavior (de facto implementation).
Policymakers seeking low inflation should ensure that institutional declarations about exchange rate arrangements are backed by observable exchange rate behavior to effectively anchor expectations.
De jure adherence to a pegged regime without corresponding de facto actions is unlikely to deliver the full inflation benefits of pegging; likewise, de facto pegging without clear de jure commitment is of limited value.

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