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Money-Based versus Exchange Rate-Based Stabilization with Endogenous Fiscal Policy

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Aaron Tornell
Andres Velasco

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Abstract

We present a standard intertemporal model in which fiscal policy is determined by an optimizing but non-benevolent fiscal authority. If the fiscal authority is impatient, a money-based stabilization provides more fiscal discipline and higher welfare for the representative agent than does an exchange rate-based stabilization. Data for Latin American stabilizations in the last quarter-century seem to confirm the notion that stabilizing by using money rather than the exchange rate helps induce politicians to reduce the fiscal deficit.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5300.

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Date of creation: Oct 1995
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Handle: RePEc:nbr:nberwo:5300

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Calvo, Guillermo A & Vegh, Carlos A, 1994. "Inflation Stabilization and Nominal Anchors," Contemporary Economic Policy, Oxford University Press, vol. 12(2), pages 35-45, April.
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  2. Kiguel, Miguel A. & Liviatan, Nissan, 1992. "Stopping three big inflations (Argentina, Brazil, and Peru)," Policy Research Working Paper Series 999, The World Bank. [Downloadable!]
  3. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1995. "The Collapse of the Mexican Peso: What Have We Learned?," NBER Working Papers 5142, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August. [Downloadable!] (restricted)
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  5. Paul R. Masson & Jacob A. Frenkel & Morris Goldstein, 1991. "Characteristics of a Successful Exchange Rate System," IMF Occasional Papers 82, International Monetary Fund.
  6. Corbo, Vittorio & de Melo, Jaime, 1987. "Lessons from the Southern Cone Policy Reforms," World Bank Research Observer, Oxford University Press, vol. 2(2), pages 111-42, July.
  7. Kathryn M. Dominguez, 1991. "Do Exchange Auctions Work? An Examination of the Bolivian Experience," NBER Working Papers 3683, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  9. Maurice Obstfeld, 1986. "Floating Exchange Rates: Experience and Prospects," NBER Reprints 0792, National Bureau of Economic Research, Inc.
  10. Klein, Michael W. & Marion, Nancy P., 1997. "Explaining the duration of exchange-rate pegs," Journal of Development Economics, Elsevier, vol. 54(2), pages 387-404, December. [Downloadable!] (restricted)
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  11. Liviatan, Nissan, 1984. "Tight money and inflation," Journal of Monetary Economics, Elsevier, vol. 13(1), pages 5-15, January. [Downloadable!] (restricted)
  12. Calvo, Guillermo A, 1986. "Fractured Liberalism: Argentina under Martinez de Hoz," Economic Development and Cultural Change, University of Chicago Press, vol. 34(3), pages 511-33, April.
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  1. Chris Canavan & Mariano Tommasi, 1997. "Visibility and Credibility in the Political Economy of Reform," Boston College Working Papers in Economics 346., Boston College Department of Economics. [Downloadable!]
  2. Oliver Grimm, 2007. "Fiscal Discipline and Stability under Currency Board Systems," Economics working paper series 07/66, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich. [Downloadable!]
  3. Hanns-Dieter Jacobsen et. al, 2004. "Economic, Political, Institutional as well as Social Risks and Opportunities of EMU Enlargement," Eastward Enlargement of the Euro-zone Working Papers wp22, Free University Berlin, Jean Monnet Centre of Excellence, revised 01 Jun 2004. [Downloadable!]
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