Re: dollarization

[Colin Danby <danbyc@xxxxxxx>]

Thanks to Alan for clarifying his views off-list.

These are supplementary remarks to my lengthy posting at
http://csf.Colorado.EDU/forums/pkt/2000/msg02540.html  The purpose is to
write down the relevant assumptions behind the meanings of
"credibility."

1. The term is commonly used, in business journalism and the
conversation of market participants, as a synonym for devaluation risk.
This is how I interpret Henry's use of it, though I may be wrong.  Here
assumptions are (a) a pegged exchange rate, (b) frictionless trade in
currencies, and (c) that in comparing bonds in the country with the peg
and the country whose currency is used for the peg, we can distinguish
default risks from devaluation risk, and further abstract away from
consequential differences in the liquidity of the relevant bond
markets.  Thus if we can compare an Argentine bond and a U.S. bond with
identical default risks (and maturities) and similarly-liquid markets,
the remaining spread is the devaluation risk over the relevant time
period.  The size of this spread may be termed a measure of the
"credibility" with which "the market" views the peg.  Note that on these
terms the word "credibility" adds no extra insight.  One might expect a
peg to collapse for any number of reasons.

2. A second meaning, with more analytical content, is the notion that
policymakers communicate certain preferences or characteristics or
decision rules to the outside world and may try to embed them in
institutional structures, treaties, laws, personnel, and so forth.  This
is patently true.  The degree to which policymakers convince people that
they will act in certain ways in certain circumstances may be termed
"credibility."

Credibility in sense 1 can only be a measure of credibility in sense 2
(for a peg) if one makes a series of additional political economy and
macro assumptions.  One example is the neoclassical credibility
literature as I noted in my last posting.  There may be others, but in
general it would appear that *if* we are not making simpleminded
monetarist assumptions that mischief always starts with loose money,
*then* we are essentially saying that policymakers will make sure that
pressure on the peg is borne by workers or by certain kinds of business
or by damaging the domestic financial system or by something else,
rather than by abandoning the peg.  Hence my repeated and vociferous
objections to equating "credibility" in this sense with
de-politicization.  In fact the whole point of this sort of
"credibility" is that it *is* political, as Barkley pointed out.  What
policymakers try to do is set the politics in stone via inflexible
institutions.

Best, Colin