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The syndrome of exchange-rate-based stabilizations and the uncertain duration of currency pegs

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  • Enrique G. Mendoza
  • Martin Uribe

Abstract

This paper shows that some key stylized facts of exchange-rate-based stabilization plans can be explained by the uncertain duration of the plans themselves. Uncertain duration is modeled to reflect evidence showing that devaluation probabilities are higher when the plans are introduced and abandoned than in the period in between. If contingent-claims markets are incomplete, this uncertain duration distortion introduces temporary fiscal cuts with large wealth effects. Investment and employment are also distorted, and the resulting supply-side effects play a critical role. Stabilizations of uncertain duration entail large welfare costs, but they are preferred to persistent high inflation. Mexico's experience is examined in the light of these predictions.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Discussion Paper / Institute for Empirical Macroeconomics with number 121.

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Date of creation: 1997
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Handle: RePEc:fip:fedmem:121

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Keywords: Money ; Foreign exchange - Law and legislation ; Foreign exchange rates;

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Cited by:
  1. Cunha, Alexandre B., 2002. "Optimal Exchange Rate Policy, Optimal Incomplete Taxation and Business Cycles," Insper Working Papers wpe_16, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  2. Kamin, Steven B., 2001. "Real exchange rates and inflation in exchange-rate-based stabilizations: an empirical examination," Journal of Development Economics, Elsevier, vol. 64(1), pages 237-253, February.
  3. Uribe, Martin, 1999. "Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies," Journal of Development Economics, Elsevier, vol. 59(2), pages 295-318, August.
  4. Marla Ripoll, 2005. "Real Exchange Rate Targeting, Macroeconomic Performance and Sectoral Income Distribution in Developing Countries," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 14(2), pages 167-196.
  5. Norbert Fiess & Marco fugazza & William Maloney, 2002. "Exchange Rate Appreciations, Labor Market Rigidities, and Informality," Working Papers 2005_15, Business School - Economics, University of Glasgow.
  6. Venegas-Martinez, Francisco, 2001. "Temporary stabilization: A stochastic analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 25(9), pages 1429-1449, September.
  7. Kamin, Steve B. & Rogers, John H., 2000. "Output and the real exchange rate in developing countries: an application to Mexico," Journal of Development Economics, Elsevier, vol. 61(1), pages 85-109, February.
  8. Kolver Hernandez, 2004. "State-Dependent Nominal Rigidities & Disinflation Programs in Small Open Economies," Macroeconomics 0411021, EconWPA.
  9. Martin Uribe, 1996. "The Tequila effect: theory and evidence from Argentina," International Finance Discussion Papers 552, Board of Governors of the Federal Reserve System (U.S.).
  10. Amartya Lahiri, 1996. "Exchange Rate Based Stabilizations Under Real Frictions: The role of endagenous labor supply," UCLA Economics Working Papers 759, UCLA Department of Economics.
  11. Mendoza, Enrique G. & Uribe, Martin, 2000. "Devaluation risk and the business-cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 239-296, December.
  12. Lahiri, Amartya, 2000. "Disinflation programs under policy uncertainty," Journal of International Economics, Elsevier, vol. 50(2), pages 351-373, April.
  13. Steven B. Kamin & Marc Klau, 1998. "Some multi-country evidence on the effects of real exchange rates on output," International Finance Discussion Papers 611, Board of Governors of the Federal Reserve System (U.S.).
  14. Francisco Venegas-Martinez & Ambrosio Ortiz-Ramírez & Francisco Ortiz-Arango, 2012. "Temporary stabilization: a Fréchet-Weibullextreme value distribution approach," EconoQuantum, Revista de Economia y Negocios, Universidad de Guadalajara, Centro Universitario de Ciencias Economico Administrativas, Departamento de Metodos Cuantitativos y Maestria en Economia., vol. 9(1), pages 35-55, Enero-Jun.
  15. Francisco Venegas-Martínez, 2005. "Temporary Stabilization and the Real Option of Waiting when Consumption can be Delayed: an Extreme Value Approach," DEGIT Conference Papers c010_043, DEGIT, Dynamics, Economic Growth, and International Trade.
  16. Buffie, Edward F., 1999. "Optimal trade liberalization and the welfare costs of imperfect credibility," Journal of International Economics, Elsevier, vol. 47(2), pages 371-398, April.
  17. Buffie, Edward F. & Atolia, Manoj, 2012. "Resurrecting the weak credibility hypothesis in models of exchange-rate-based stabilization," European Economic Review, Elsevier, vol. 56(3), pages 361-372.
  18. Venegas-Martinez, Francisco, 2006. "Stochastic temporary stabilization: Undiversifiable devaluation and income risks," Economic Modelling, Elsevier, vol. 23(1), pages 157-173, January.

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