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Inflation in nontradables and the macroeconomic policy mix : a model with policy application to transition economies

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  • Polackova, Hana

Abstract

The author analyzes the macroeconomic effects of inflation in the nontradables sector of a small open economy to suggest how different macroeconomic policies would facilitate structural adjustment after price liberalization in a transition economy. She uses a Mundell-Fleming rational expectations model of a two-sector economy to study how inflation in the nontradables sector affects the exchange rate, relative prices, wages, and, indirectly, the movement of factors of production. She applies the analysis to a cut in producer subsidies in the nontradables sector and assesses how macroeconomic policies involving the management of supply and demand might affect government objectives for the economy and redistribution. She concludes that to alleviate the transitory negative effects of a cut in producer subsidies, targeted household transfers combined with a tax cut, if possible, are superior to expansionary monetary and fiscal policies. Making the tax cut less than the cut in subsidies and financing targeted lump-sum household transfers from government savings reduce the risk of poverty and external imbalances. The potential benefits from exchange rate management depend greatly on the level of wage discipline.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1702.

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Date of creation: 28 Feb 1997
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Handle: RePEc:wbk:wbrwps:1702

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Keywords: Fiscal&Monetary Policy; Economic Theory&Research; Environmental Economics&Policies; Markets and Market Access; Payment Systems&Infrastructure; Economic Theory&Research; Economic Stabilization; Environmental Economics&Policies; Access to Markets; Markets and Market Access;

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  1. Bruno, Michael, 1976. "The Two-Sector Open Economy and the Real Exchange Rate," American Economic Review, American Economic Association, vol. 66(4), pages 566-77, September.
  2. Kenneth Rogoff, 1992. "Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 10(2), pages 1-29, November.
  3. Krugman, Paul & Taylor, Lance, 1978. "Contractionary effects of devaluation," Journal of International Economics, Elsevier, vol. 8(3), pages 445-456, August.
  4. Marston, Richard C., 1985. "Stabilization policies in open economies," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 17, pages 859-916 Elsevier.
  5. Richard C. Marston, 1983. "Stabilization Policies in Open Economies," NBER Working Papers 1117, National Bureau of Economic Research, Inc.
  6. T. W.Swan, 1960. "Economic Control In A Dependent Economy," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 51-66, 03.
  7. International Monetary Fund, 1985. "Formulation of Exchange Rate Policies in Adjustment Programs," IMF Occasional Papers 36, International Monetary Fund.
  8. Lawrence Schembri, 1988. "Macro-economic Stability and Policy Rules in a Two-Sector Model of an Open Economy," Canadian Journal of Economics, Canadian Economics Association, vol. 21(1), pages 87-96, February.
  9. Helpman, Elhanan, 1977. "Nontraded Goods and Macroeconomic Policy under a Fixed Exchange Rate," The Quarterly Journal of Economics, MIT Press, vol. 91(3), pages 469-80, August.
  10. Meade, James & Vines, David, 1988. "Monetary Policy and Fiscal Policy: Impact Effects with a New Keynesian `Assignment' of Weapons to Targets," CEPR Discussion Papers 246, C.E.P.R. Discussion Papers.
  11. Thomas Moutos, 1990. "The Effects of Government Policies in a Macromodel with Multinational Corporations," Working Papers Series 90/10, University of Stirling, Division of Economics.
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