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Fiscal Deficits, Exchange Rate Crises and Inflation

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  • van Wijnbergen, Sweder

Abstract

This paper extends earlier work on unsustainable monetary policies by endogenizing the regime switch that ultimately restores sustainability. Within this framework we analyze exchange rate based stabilization programs and shows how constraints on Central Bank borrowing during an exchange crisis influence timing and nature of the post-collapse equilibrium. Such constraints introduce non-neutralities; more restrictive pre-collapse credit policies increase the post-collapse inflation rate. External shocks can destroy consistency between fiscal programs and inflation targets, causing reserve losses, exchange rate changes and higher inflation. Balance of Payments crises are the mechanism through which fiscal imbalances translate into higher inflation rather than an alternative explanation of it. Copyright 1991 by The Review of Economic Studies Limited.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of Economic Studies.

Volume (Year): 58 (1991)
Issue (Month): 1 (January)
Pages: 81-92

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Handle: RePEc:bla:restud:v:58:y:1991:i:1:p:81-92

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  1. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  2. Rudiger Dornbusch & Stanley Fischer, 1986. "Stopping Hyperinflations Past and Present," NBER Working Papers 1810, National Bureau of Economic Research, Inc.
  3. Willem H. Buiter, 1982. "Comment on T. J. Sargent and N. Wallace: "Some Unpleasant Monetarist Arithmetic"," NBER Working Papers 0867, National Bureau of Economic Research, Inc.
  4. Allan Drazen & Elhanan Helpman, 1986. "Inflationary Consequences of Anticipated Macroeconomic Policies," NBER Working Papers 2006, National Bureau of Economic Research, Inc.
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  7. Obstfeld, Maurice, 1981. "Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1142-61, December.
  8. Flood, Robert P & Garber, Peter M, 1980. "An Economic Theory of Monetary Reform," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 24-58, February.
  9. Liviatan, Nissan, 1984. "Tight money and inflation," Journal of Monetary Economics, Elsevier, vol. 13(1), pages 5-15, January.
  10. Stephen W. Salant & Dale W. Henderson, 1976. "Market anticipations, government policy, and the price of gold," International Finance Discussion Papers 81, Board of Governors of the Federal Reserve System (U.S.).
  11. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March.
  12. Elhanan Helpman & Assaf Razin, 1985. "Exchange Rate Management: Intertemporal Tradoffs," NBER Working Papers 1590, National Bureau of Economic Research, Inc.
  13. Drazen, Allan, 1985. "Tight money and inflation: Further Results," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 113-120, January.
  14. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  15. Kharas, Homi, 1984. "The Long-Run Creditworthiness of Developing Countries: Theory and Practice," The Quarterly Journal of Economics, MIT Press, vol. 99(3), pages 415-39, August.
  16. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  17. Willem H. Buiter, 1986. "Borrowing to Defend the Exchange Rate and the Timing and Magnitude of Speculative Attacks," NBER Working Papers 1844, National Bureau of Economic Research, Inc.
  18. Chamley, Christophe, 1985. "On a simple rule for the optimal inflation rate in second best taxation," Journal of Public Economics, Elsevier, vol. 26(1), pages 35-50, February.
  19. Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
  20. Blanco, Herminio & Garber, Peter M, 1986. "Recurrent Devaluation and Speculative Attacks on the Mexican Peso," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 148-66, February.
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