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Do Exchange Rate-Based Stabilizations Carry the Seeds of Their Own Destruction?

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  • Reinhart, Carmen
  • Vegh, Carlos

Abstract

Most of the major exchange rate-based stabilizations (ERRS) in chronic inflation countries in the last 30 years have ended in spectacular financial and balance of payments crises. Moreover, there is a stunning resemblance in the dynamics of the main macroeconomic variables in all these programs. In the first stages, inflation falls, the economy expands, and consumer spending (particularly of durable goods) explodes. In light of this, the figure of the Finance Minister takes God¬like proportions. Shortly thereafter, however, the “dark side” of ERRS emerges. The slow convergence of inflation fuels a large real exchange rate appreciation which, together with the fall in private saving, lead to large current account imbalances and overborrowing. At this stage, the Finance Minister faces an unenviable dilemma: deflation or devaluation. Often forced by a run on the currency, he or she is eventually left with no choice but to devalue and then, having broken the no-devaluation pledge, is forced out of office, vilified, and blamed for most of the economic ills of the country.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 8952.

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Date of creation: 1999
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Handle: RePEc:pra:mprapa:8952

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References

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  1. Sergio Rebelo & Carlos A. Vegh, 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 125-188 National Bureau of Economic Research, Inc.
  2. Carlos A. Végh, 1992. "Stopping High Inflation: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 626-695, September.
  3. Kiguel, Miguel A & Liviatan, Nissan, 1992. "The Business Cycle Associated.with Exchange Rate-Based Stabilizations," World Bank Economic Review, World Bank Group, vol. 6(2), pages 279-305, May.
  4. Drazen, Allan & Helpman, Elhanan, 1987. "Stabilization with Exchange Rate Management," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 835-55, November.
  5. Calvo, Guillermo A. & Vegh, Carlos A., 1994. "Stabilization dynamics and backward-looking contracts," Journal of Development Economics, Elsevier, vol. 43(1), pages 59-84, February.
  6. Calvo, Guillermo A, 1986. "Temporary Stabilization: Predetermined Exchange Rates," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1319-29, December.
  7. Rodriguez, Carlos Alfredo, 1982. "The Argentine stabilization plan of December 20th," World Development, Elsevier, vol. 10(9), pages 801-811, September.
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Cited by:
  1. Stanley Fischer & Ratna Sahay & Carlos A. Vegh, 2002. "Modern Hyper- and High Inflations," NBER Working Papers 8930, National Bureau of Economic Research, Inc.
  2. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  3. Edward F. Buffie & Manoj Atolia, 2006. "Resurrecting the Weak Credibility Hypothesis in Models of Exchange-Rate-Based Stabilization," Working Papers wp2009_01_03, Department of Economics, Florida State University, revised Aug 2007.
  4. Gonzalo Caprirolo & Vladimir Lavrac, 2003. "Monetary and Exchange Rate Policy in Slovenia," Eastward Enlargement of the Euro-zone Working Papers wp17g, Free University Berlin, Jean Monnet Centre of Excellence, revised 01 May 2003.
  5. Bekaert, Geert & Harvey, Campbell R. & Lumsdaine, Robin L., 2002. "Dating the integration of world equity markets," Journal of Financial Economics, Elsevier, vol. 65(2), pages 203-247, August.
  6. Sweta Saxena & Kar-yiu Wong, 1999. "Currency Crises and Capital Control: A Survey," Working Papers 0045, University of Washington, Department of Economics.
  7. Reinhart, Carmen & Kaminsky, Graciela, 2000. "Las crisis gemelas: las causas de los problemas bancarios y de balanza de pagos
    [The twin crises: Te causes of banking and balance of payments problems]    ," MPRA Paper 13842, University Library of Munich, Germany.

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