Hyperinflation and Stabilisation: Cagan Revisited
Using a variant of the Cagan (1956) model with rational expectations, this paper shows that expected stabilization can result in a budget deficit in excess of the maximum inflation tax. A cap on the deficit dampens inflation expectations and raises real balances, thus increasing the yield of the inflation tax for any given rate of inflation. This study extends the work of Alan Drazen and Elhanan Helpman (1990) by including a stochastic budgetary process and using option pricing theory. It uses parameter values of the semielasticity of demand for money to provide estimates of the maximum viable real deficit. Copyright 1997 by Royal Economic Society.
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Volume (Year): 107 (1997)
Issue (Month): 441 (March)
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- Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, volume 1, number 5474.
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- Miller, Marcus & Zhang, Lei, 1996.
"Optimal target zones: How an exchange rate mechanism can improve upon discretion,"
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Elsevier, vol. 20(9-10), pages 1641-1660.
- Miller, Marcus & Zhang, Lei, 1994. "Optimal Target Zones: How an Exchange Rate Mechanism Can Improve Upon Discretion," CEPR Discussion Papers 1031, C.E.P.R. Discussion Papers.
- Davies, Gareth & Vines, David, 1995. "Equilibrium Currency Crises: Are Multiple Equilibria Self-fulfilling or History Dependent?," CEPR Discussion Papers 1239, C.E.P.R. Discussion Papers.
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