| Central banks that behave as if they were on the gold standard have lower and less variable inflation, and those which behave as if they were currency boards have even lower and less variable inflation. This finding, based on an analysis of 68 developing countries, leads to the following behavioral rule for central banks: Maintain the balance sheet of the central bank in at least as sound a position as it is at present. Soundness refers to the proportion of total assets that are foreign, corrected for changes in exchange rates. The higher the proportion, the more sound. A second finding, more tentative than the first, is that this practice is, costless, in that growth in output is not sacrificed by following the rule, and may be accompanied by a bonus in the form of higher growth. A third inference may be drawn from the study, even more tentative, that other functions of the central bank should not be neglected in the search for better inflation experience. This is especially true of the role of the central bank in supervision and regulation of the banking sector. |