Monetary Regimes: The Interrelated Choice of Monetary Policy and the Exchange Rate.

Why would a government ever choose to give up control over monetary policy? Fixing exchange rates has anti-inflationary benefits. However, I demonstrate that no government will opt for fixed exchange rates on the basis of that anti-inflationary benefit. In my model, any anti-inflationary effect is purely an externality of the government’s preference to reduce nominal exchange rate volatility and secure a favorable real exchange rate. While some domestic actors may favor the anti-inflationary effects of a fixed exchange rate, the government will always prefer to set its own monetary policy. I argue that the government’s choice of monetary policy and exchange rate reflects the policy preferences of powerful sectoral and class actors in the domestic economy. This paper examines the government’s choice of exchange rate and monetary policy, and how this choice is affected by the constraint on policymaking that arises from international capital mobility. [ABSTRACT FROM AUTHOR]