The syndrome of exchange-rate-based stabilizations and the uncertain duration of currency pegs
AbstractThis paper conducts a quantitative examination of the hypothesis that uncertain duration of currency pegs causes the sharp real appreciations and business cycles that affect chronically countries using fixed exchange rates as an instrument to stop high inflation. Numerical solutions of equilibrium dynamics of a two-sector small open economy with incomplete markets show that uncertain duration rationalizes the syndrome of exchange-rate-based stabilizations without price or wage rigidities. Three elements of the model are critical for these results: (a) a strictly-convex hazard rate function describing time-dependent devaluation probabilities, (b) the wealth effects introduced by incomplete insurance arkets, and (c) the supply-side effects introduced via capital accumulation and elastic labor supply. Uncertain duration also entails large welfare costs, compared to the perfect-foresight credibility framework, although temporary disinflations are welfare-improving. The model's potential empirical relevance is examined further by reviewing Mexico's post-war experience with the collapse of six currency pegs.
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Bibliographic InfoPaper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 548.
Date of creation: 1996
Date of revision:
Other versions of this item:
- Enrique G. Mendoza & Martin Uribe, 1997. "The syndrome of exchange-rate-based stabilizations and the uncertain duration of currency pegs," Discussion Paper / Institute for Empirical Macroeconomics 121, Federal Reserve Bank of Minneapolis.
- Mendoza, Enrique & Uribe, Martin, 1997. "The Syndrome of Exchange-Rate-Based Stabilizations and the Uncertain Duration of Currency Pegs," Working Papers 97-30, Duke University, Department of Economics.
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
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