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Uncertain Duration of Reform: Dynamic Implications

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  • Guillermo A. Calvo
  • Allan Drazen

Abstract

We develop a framework to study the effects of policies of uncertain duration on consumption dynamics under both complete and incomplete markets. We focus on the dynamic implications of market incompleteness, specifically on the lack of state-contingent bonds. Two policies are considered: pure output-increasing and tariff-reducing (trade liberalization). With" complete markets, the output-increasing policy leads to flat consumption, while with no contingent assets, consumption jumps upward on the announcement of the policy, continues rising as long as the policy is in effect, and collapses when it is abandoned. A similar consumption path obtains in a trade liberalization in the realistic case of low elasticity of substitution and no rebate of tariffs. Market incompleteness rationalizes the existence of gradual changes in consumption.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5925.

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Date of creation: Feb 1997
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Publication status: published as Calvo, Guillermo A. & Drazen, Allan, 1998. "Uncertain Duration Of Reform," Macroeconomic Dynamics, Cambridge University Press, vol. 2(04), pages 443-455, December.
Handle: RePEc:nbr:nberwo:5925

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  1. Guillermo Calvo & Fabrizio Coricelli, 1992. "Output Collapse in Eastern Europe," IMF Working Papers 92/64, International Monetary Fund.
  2. Reinhart, Carmen & Vegh, Carlos, 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," MPRA Paper 13898, University Library of Munich, Germany.
  3. Allan Drazen & Elhanan Helpman, 1987. "Stabilization with Exchange Rate Management under Uncertainty," NBER Working Papers 2268, National Bureau of Economic Research, Inc.
  4. Carlos A. Végh, 1992. "Stopping High Inflation: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 626-695, September.
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