the interaction between monetary policy,fiscal policy and corruption

The design of monetary policy of developing and transition countries has been subject of many discussions for a long time. Many developing and transition countries feature a deficit of credibility of monetary policy institutions, which has been systematically studied (e.g., Cukierman, 1992; Persson and Tabellini, 1990). Due to the lack of credibility, those countries are often recommended to choose a currency peg regime - whether as a unilateral peg to a dominant currency, or as a building of a monetary union, or in the form of a currency board, or dollarization. Another major feature of these economies is corruption, which includes inter alia rent-seeking behaviour of bureaucrats, weakness of public institutions, bribery and even "government pathologies", in terms of Aidt (2003). What connection exists between this phenomenon and the desirability of some popular exchange rate regimes? My analyses is drawing on two different strands of economic research. The first one includes voluminous literature concerning the choice of monetary regime (e.g., Kydland and Prescott, 1977; Barro and Gordon, 1983; Rogoff, 1985; Alesina and Tabellini, 1987; Walsh, 1995). Most authors attach great importance to institutional design of monetary policy but corruption as such is not explicitly modelled. The second strand is the research of effects of corruption, which is too extensive to be referenced here1. Following Jain (2001), one can define corruption as "an act in which the power of public office is used for personal gain in a manner that contravenes the rules of the game" but this phenomenon has many dimensions, then it provides various topics of research. However, to my knowledge the impact of corruption on the choice of monetary has not been sufficiently studied, there are only few approaches tackling this question. The first step was made by Huang and Wei (2006). They utilize a framework developed in Alesina and Tabellini (1987) based on Barro-Gordon model and find out that currency peg regimes are not the best solution. In contrast, Hefeker (2008) argues for pegging to a stable currency, because it can reduce the level of corruption. In addition, he claims that a monetary union has ambiguous impacts. In his analysis Hefeker uses a combination of the models of Huang and Wei and De Kock and Grilli (1993).In my contribution I start from the idea found in these previous works and intend to analyse the effects of corruption on the choice of exchange rate regime using the approaches from Huang und Wei und Hefeker. I aim at modifying the basic framework from Huang und Wei und Hefeker by changing the perception of the role of corruption. While the above mentioned authors regard corruption only as tax leakages, which reduce public budget and have consequently only negative effects, I additionally take into account a positive impact of corruption on the output. Firms can use the lack of institutional quality as an opportunity to avoid distortionary taxes download