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Real Balances, the Exchange Rate and Indexation: Real Variables in Disinflation

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  • Stanley Fischer
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    Abstract

    The recent appreciation of the dollar is widely believed to have reduced the output costs of the disinflation. But there remains the question of whether those early gains have to be repaid when the exchange rate depreciates.The first question taken up is the effect of real exchange rate appreciation on the sacrifice ratio, or output cost, of disinflation. There is no unambiguous presumption that exchange rate appreciation reduces the sacrifice ratio. The direct favorable effects of cheaper imports on consumer prices, on the prices of imported inputs, and on wage demands, may be outweighed by the unemployment resulting from the reduced demand for exports. In the second part of the paper I examine the affects of wage indexation on the sacrifice ratio. Economists have argued that wage indexation speeds up disinflation; policymakers take the opposite view. The distinction between ex ante and ex post indexing, defined in the paper, explains these different views. Ex ante wage indexation speeds up disinflation. With expost indexation the real wage automatically rises when the inflation rate falls. Even so, ex post indexing may speed up disinflation. But there has to be subsequent downward adjustment of the wage if long-term unemployment is to be prevented.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1497.

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    Date of creation: Nov 1984
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    Publication status: published as Fischer, Stanley. "Real Balances, the Exchange Rate and Indexation: Real Variables in Disinflation," Quarterly Journal of Economics, Vol. 103, No. 1, pp. 27-50, (February 1988).
    Handle: RePEc:nbr:nberwo:1497

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    1. Buiter, Willem H. & Miller, Marcus, 1982. "Real exchange rate overshooting and the output cost of bringing down inflation," European Economic Review, Elsevier, Elsevier, vol. 18(2), pages 85-123.
    2. Okun, Arthur M, 1978. "Efficient Disinflationary Policies," American Economic Review, American Economic Association, American Economic Association, vol. 68(2), pages 348-52, May.
    3. Backus, David & Driffill, John, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 52(2), pages 211-21, April.
    4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    5. Robert J. Gordon, 1981. "Inflation, Flexible Exchange Rates, and the Natural Rate of Unemployment," NBER Working Papers 0708, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Usman A. Afridi & Rehana Siddiqui, 1994. "Framework for Deriving Real Exchange Rates," The Pakistan Development Review, Pakistan Institute of Development Economics, Pakistan Institute of Development Economics, vol. 33(4), pages 1099-1112.
    2. Vittorio Corbo & Stanley Fischer, . "Lessons from the Chilean Stabilization and Recovery," Documentos de Trabajo, Instituto de Economia. Pontificia Universidad Católica de Chile. 158, Instituto de Economia. Pontificia Universidad Católica de Chile..
    3. Esteban Jadresic, 1998. "The Macroeconomic Consequences of Wage Indexation Revisited," IMF Working Papers 98/15, International Monetary Fund.
    4. Federico Echenique & Alvaro Forteza, 2000. "Are stabilization programs expansionary?," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 15(1), pages 65-89.
    5. Marc Hofstetter, 2004. "Disinflations in Latin America and the Caribbean: A Free Lunch?," Economics Working Paper Archive, The Johns Hopkins University,Department of Economics 506, The Johns Hopkins University,Department of Economics.
    6. Frankel, Jeffrey A., 2011. "Monetary Policy in Emerging Markets: A Survey," Scholarly Articles 4669671, Harvard Kennedy School of Government.
    7. Marek Dabrowski, 2002. "Currency Crises in Emerging - Market Economis: Causes, Consequences and Policy Lessons," CASE Network Reports 0051, CASE-Center for Social and Economic Research.
    8. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden Stops," IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 1-49, June.
    9. Sebastian Edwards, 2001. "Does the Current Account Matter?," NBER Working Papers 8275, National Bureau of Economic Research, Inc.
    10. Corbo, Vittorio & Solimano, Andres, 1991. "Chile's experience with stabilization, revisited," Policy Research Working Paper Series 579, The World Bank.
    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. Vittorio Corbo, . "Reducing Inflation. The Chilean Experience," Documentos de Trabajo, Instituto de Economia. Pontificia Universidad Católica de Chile. 185, Instituto de Economia. Pontificia Universidad Católica de Chile..
    13. Vittorio Corbo, 1998. "Reaching One-Digit Inflation: The Chilean Experience," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 123-163, November.
    14. Milesi-Ferretti, Gian Maria, 1995. "A simple model of disinflation and the optimality of doing nothing," European Economic Review, Elsevier, Elsevier, vol. 39(7), pages 1385-1404, August.
    15. Vegh, Carlos, 1991. "Stopping High Inflation: An Analytical Overview," MPRA Paper 20175, University Library of Munich, Germany.
    16. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals and Sudden Stops," NBER Working Papers 10276, National Bureau of Economic Research, Inc.
    17. M. Ali Choudhary & Saima Mahmood & Sajawal Khan & Waqas Ahmed & Gylfi Zoega, 2013. "Sticky Wages in a Developing Country: Lessons from Structured Interviews in Pakistan," School of Economics Discussion Papers, School of Economics, University of Surrey 0213, School of Economics, University of Surrey.

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