ANNALS OF ECONOMICS AND FINANCE 14-2(B), 813–852 (2013) Currency Boards, Credibility, and Macroeconomic Behavior

Currency boards operate differently from standard pegs. The former exhibit greater currency stability and lower transaction costs, inflation, and nominal interest rates, but are limited in their use of devaluation. We extend Drazen and Masson’s (1994) signaling model to consider the choice between curren-cy board arrangements and standard pegs. The model shows that currency boards ’ effectiveness hinges on their credibility properties and that they can improve welfare even with high unemployment persistence. By reducing ex-pected inflation and the negative employment effect arising from expected but unrealized inflation, currency boards can produce less unemployment than peg regimes that abstain from devaluation. 1