Endogenous credibility and stabilization programmes: evidence from the Dominican Republic

Abstract

This paper analyses the impact of policy misalignments and structural reform policies on credibility and the long-term success of an exchange rate based (ERB) stabilization programme to reduce inflationary inertia. A controlled signal state-space model is used to test this hypothesis for the Dominican Republic, a country that introduced an ERB programme in the early 1990s. The results indicate that fiscal and monetary malpractice will deteriorate credibility whereas structural reform policies, when perceived as beneficial, will enhance credibility, contributing to economic stability.