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Resurrecting the Weak Credibility Hypothesis in Models of Exchange-Rate-Based Stabilization

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Author Info
Edward F. Buffie () (Department of Economics, Indiana University)
Manoj Atolia () (Department of Economics, Florida State University)

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Abstract

We analyze how weak credibility affects the volatility of consumption spending in a model of exchange-rate-based stabilization that allows for both durable and nondurable goods. The inclusion of durables greatly improves the explanatory power of the weak credibility hypothesis. The hypothesis can account for the main qualitative properties of the boom-bust cycle provided the elasticity of durables expenditure with respect to Tobin’s q is greater than the intertemporal elasticity of substitution. Moreover, the quantitative effects are very large. In numerical simulations based on conservative assumptions about the expenditure share of durables (20%) and wealth effects (none), aggregate consumption increases 12-28% during the low-crawl phase and the real exchange rate appreciates 24-26%. In variants of the model that incorporate supply effects, the consumption boom is equally strong but appreciation of the real exchange rate rises to 30-40%.

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File URL: ftp://econpapers.fsu.edu/RePEc/fsu/wpaper/wp2009_01_03.pdf
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Paper provided by Department of Economics, Florida State University in its series Working Papers with number wp2009_01_03.

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Length: 57
Date of creation: Jun 2006
Date of revision: Aug 2007
Handle: RePEc:fsu:wpaper:wp2009_01_03

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Related research
Keywords: Credibility; exchange-rate-based stabilization; durables;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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