Monetary Policies for Developing Countries: The Role of Corruption

Abstract

This paper examines the role of corruption in the design of monetary policies for developing countries in a framework of fiscal and monetary interaction and obtains several interesting results. First, pegged exchange rates, currency boards, or dollarization, while often prescribed as a solution to the problem of a lack-of-credibility for developing countries, is typically not credible in countries with serious corruption. Second, the optimal degree of conservatism for a Rogoff (1985)-type central banker is an inverse function of the corruption level. Third, either an optimally-designed inflation target or an optimal conservative central banker is preferable to an exchange rate peg, currency board or dollarization.

Keywords: corruption, fiscal policy, monetary policy, inflation targeting, currency board, dollarization, conservative central banker

JEL Classification: E52, E58, E61, E62, H50