Signalling the Strength of an Exchange Rate Commitment.

The conditions under which a policymaker might rationally signal the strength of an exchange rate commitment by revaluation are considered. We derive an intuitive result: the policymaker signals strong commitment by revaluation if initial credibility is low, but will refrain from doing so if credibility is already high, as any such signal is costly. The analysis suggests that if an exchange rate rule is intended to improve anti-inflation credibility, then it ought to be sufficiently flexible to allow for orderly revaluations of the exchange rate against the anchor currency. Copyright 2001 by Blackwell Publishers Ltd and The Victoria University of Manchester