ABSTRACT
In this chapter, the authors compare exchange rate policies in the three Baltic states—Estonia, Latvia and Lithuania—and evaluate their success in reducing inflation and establishing the credibility of their anti-inflationary strategies. A comparison of these countries is interesting because they chose different paths towards macroeconomic stabilization despite their similarities as very small, rapidly opening, transition economies. The authors evaluate the credibility of the currencies and inflation performance under different regimes using the differential between interest rates in domestic and foreign currencies within each country as a proxy for credibility. They discuss the problems that political risk can generate for using this proxy, and argue that the differences between the interest rate on foreign currency deposits in each of the countries and a world market interest rate are a better measure of exchange rate credibility. Using this proxy, differences in the exchange rate credibility generated by the different strategies of the Baltic states appear to be much less.
