ABSTRACT
This chapter reviews the theoretical literature on the rules vs. discretion debate around the theory of exchange-rate targeting vs. monetary targeting as optimal strategies in the attempt to achieve price stability. A variety of arguments have been proposed favouring the adoption of fixed exchange-rate arrangements. The chapter addresses the rules vs. discretion debate and the credibility issue, in the light of current economic theory; a brief overview of stabilisation experiments, focusing on the choice between a money-supply-based or an exchange-rate-based stabilisation programme; basic formal approaches to exchange-rate regimes incorporating the credibility issue. Most of the models show that the credibility of fixed exchange-rate policies is negatively affected by indexation, demand shocks, and adverse changes in government expenditures and the level of public external debt. Empirical evidence appears today to suggest that such credibility is best secured by government commitment to a publicly visible foreign exchange link or peg with a recognised hard currency.
