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Exchange-rate-based inflation stabilization: The initial real effects of credible plans

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  • Uribe, Martin

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.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 39 (1997)
Issue (Month): 2 (July)
Pages: 197-221

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Handle: RePEc:eee:moneco:v:39:y:1997:i:2:p:197-221

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  2. Rodriguez, Carlos Alfredo, 1982. "The Argentine stabilization plan of December 20th," World Development, Elsevier, vol. 10(9), pages 801-811, September.
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  11. Martin Uribe, 1995. "Exchange-rate based inflation stabilization: the initial real effects of credible plans," International Finance Discussion Papers 503, Board of Governors of the Federal Reserve System (U.S.).
  12. Obstfeld, Maurice, 1985. "The Capital Inflows Problem Revisited: A Stylized Model of Southern Cone Disinflation," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 605-25, October.
  13. Drazen, Allan & Helpman, Elhanan, 1987. "Stabilization with Exchange Rate Management," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 835-55, November.
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  15. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April.
  16. Helpman, Elhanan & Razin, Assaf, 1984. "The role of saving and investment in exchange rate determination under alternative monetary mechanisms," Journal of Monetary Economics, Elsevier, vol. 13(3), pages 307-325, May.
  17. Reinhart, Carmen & Vegh, Carlos, 1994. "Intertemporal consumption substitution and inflation stabilization:An empirical investigation," MPRA Paper 13427, University Library of Munich, Germany.
  18. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
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