Exchange rate regimes, inflation and output volatility in developing countries

The median developing country has had significantly higher inflation than the median advanced country since the early 1980s. A model is presented in which a developing country may reduce inflationary expectations by pegging its exchange rate to the currency of an advanced country (or a basket of such currencies), at the expense of forgoing its ability to compensate for real exchange rate shocks. Different types of pegged exchange rate offer varying degrees of anti-inflation credibility and of exposure to shocks. Tests on a sample of 80 developing countries support the empirical predictions of the model