Do Fixed Exchange Rates Induce More Fiscal Discipline?

Download or read book Do Fixed Exchange Rates Induce More Fiscal Discipline? written by Mr.Yan Sun and published by International Monetary Fund. This book was released on 2003-04-01 with total page 32 pages. Available in PDF, EPUB and Kindle. Book excerpt: Conventional wisdom has held that a fixed exchange rate regime induces more fiscal discipline, but Tornell and Velasco (1995, 1998) argue the opposite. Using a dynamic model with fragmented fiscal policymaking, this paper evaluates the two arguments in a single framework and shows that (1) future punishment against fiscal laxity exists under both fixed and flexible regimes; (2) fiscal authorities have a greater incentive to spend more today under fixed rates than under flexible rates; (3) in the presence of both factors above, fixed rates will induce more fiscal discipline only if the future punishment is sufficiently stronger than under flexible rates; and (4) neither fixed nor flexible rates could resolve the structural distortions caused by fragmented policymaking, and fiscal centralization needs to be undertaken to strengthen fiscal discipline.