International Finance Discussion Papers (IFDP)
March 1995
Exchange-Rate Based Inflation Stabilization: The Initial Real Effects of Credible Plans
Martin Uribe
Abstract:
This paper presents a dynamic general equilibrium model of a small, open, monetary economy in order to analyze the short-run effects of credible stabilization plans that fix the nominal exchange rate in a regime of free convertibility. In this model inflation acts as a tax on domestic market transactions. In particular, it generates a wedge between the rate of return on investment in domestic capital and the rate of return on investment in foreign assets. The model stresses the importance of adjustment costs (including gestation lags) in explaining the precise character of the initial dynamics. The main stylized facts of this type of programs namely an initial phase characterized by several months of real exchange rate appreciation, trade balance deterioration and expansion in aggregate demand and production, followed by a deflationary slowdown in real activity, are replicated without resorting to credibility problems, sticky prices, adaptive expectations, or gradual disinflation schemes. Finally, the model is calibrated using long-run relations from the Argentinean economy, and its quantitative predictions are compared to the initial effects of that country's Convertibility Plan of April 1991.
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.