December 1, 2005.
NOTE: At the time of publication, the author Eduardo Zambrano was not yet affiliated with Cal Poly.
Numeraire choice is often deemed a problem of purely analytical convenience. In this paper I show that there is more to numeraire selection than meets the eye for the formulation of monetary policy in countries with weak fiscal institutions. I show how (a) improper numeraire choice can dramatically overstate or understate Central Bank profits and (b) how this can threaten the ability of a Central Bank to keep inflation under control. I show point (a) in the context of Monte Carlo experiments calibrated for the Venezuelan economy and point (b) in an infinitely lived representative agent model that illustrates the problem of joint determination of the ideal level of foreign currency reserves and of the desired level of transfers of Central Bank profits to the Treasury when the objective is to eliminate the possibility of a hyperinflation.
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