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The Effects of Temporary Exchange-Rate-Based Stabilizations when Money Serves a Productive Role

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  • Jesper Rangvid
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    Abstract

    This paper investigates the effects on production, consumption, and welfare that result from a temporary exchange-rate-based (ERB) stabilization plan. The analysis is based on a dynamic optimizing model of a small open economy where real money is assumed to be a factor that is used in the production of goods. The assumption of money serving a productive role makes the model capable of generating a boom-bust cycle in output, as is often experienced during ERB stabilization plans. It is shown that if the stabilization plan is expected not to be too short and/or the costs associated with the breakdown of the plan are not too high, a temporary decrease in the rate of exchange rate devaluation will increase economic welfare. It is also found that if some of the increase in output in the initial phase of the stabilization plan is saved for periods after the plan has broken down, there is a greater chance that the ERB plan will increase economic welfare. On the other hand, if the plan is not sufficiently credible at the outset, or there is not enough intertemporal transference of output, the stabilization plan is likely to be harmful to economic welfare. Copyright Springer Science+Business Media, LLC 2007

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    File URL: http://hdl.handle.net/10.1007/s11079-007-9033-9
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    Bibliographic Info

    Article provided by Springer in its journal Open Economies Review.

    Volume (Year): 18 (2007)
    Issue (Month): 4 (September)
    Pages: 453-477

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    Handle: RePEc:kap:openec:v:18:y:2007:i:4:p:453-477

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    Web page: http://www.springerlink.com/link.asp?id=100323

    Related research

    Keywords: Exchange-rate-based stabilization plans; Temporariness; Non-neutrality of money; Boom-bust output cycles; Speculative currency attacks; E51; E52; F31; F41;

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    References

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    1. Benhabib, J. & Farmer, R.E.A., 1999. "The Monetary Transmission Mechanism," Economics Working Papers eco99/35, European University Institute.
    2. Calvo, Guillermo A, 1979. "On Models of Money and Perfect Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(1), pages 83-103, February.
    3. Daniel, Betty C., 2000. "The timing of exchange rate collapse," Journal of International Money and Finance, Elsevier, vol. 19(6), pages 765-784, December.
    4. Tornell, Aaron & Velasco, Andres, 2000. "Fixed versus flexible exchange rates: Which provides more fiscal discipline?," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 399-436, April.
    5. Stanley Fischer & Ratna Sahay & Carlos A. V�gh, 2002. "Modern Hyper- and High Inflations," Journal of Economic Literature, American Economic Association, vol. 40(3), pages 837-880, September.
    6. Gylfason, T., 1996. "Output Gains from Economic Stabilization," Papers 606, Stockholm - International Economic Studies.
    7. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
    8. 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.
    9. Tornell, Aaron & Velasco, Andres, 1998. "Fiscal discipline and the choice of a nominal anchor in stabilization," Journal of International Economics, Elsevier, vol. 46(1), pages 1-30, October.
    10. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1999. "Monetary Policy and Multiple Equilibria," Departmental Working Papers 199914, Rutgers University, Department of Economics.
    11. Guillermo A. Calvo & Carlos A. Vegh, 1999. "Inflation Stabilization and BOP Crises in Developing Countries," NBER Working Papers 6925, National Bureau of Economic Research, Inc.
    12. repec:fth:starer:9613 is not listed on IDEAS
    13. Sebastian Edwards & Carlos A. Végh, 1997. "Banks and Macroeconomic Disturbances Under Predetermined Exchange Rates," CEMA Working Papers: Serie Documentos de Trabajo. 115, Universidad del CEMA.
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