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Stabilization dynamics and backward-looking contracts

  • Calvo, Guillermo A.
  • Vegh, Carlos A.

Exchange rate-based stabilizations often result in an initial output expansion. One explanation for this phenomenon has been that, in the presence of inflation inertia, a reduction in the nominal interest rate causes the domestic real interest rate to fall, thus increasing aggregate demand. This paper reexamines this issue in the context of an intertemporal optimizing model. In contrast to previous results, the analysis shows that, if the intertemporal elasticity of substitution is smaller than the elasticity of substitution between traded and home goods, a permanent reduction in the rate of devaluation leads to a fall in aggregate demand.

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Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 43 (1994)
Issue (Month): 1 (February)
Pages: 59-84

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Handle: RePEc:eee:deveco:v:43:y:1994:i:1:p:59-84
Contact details of provider: Web page: http://www.elsevier.com/locate/devec

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  1. Jonathan David Ostry & Carmen Reinhart, 1991. "Private Saving and Terms of Trade Shocks: Evidence From Developing Countries," IMF Working Papers 91/100, International Monetary Fund.
  2. Dornbusch, Rudiger, 1982. "Stabilization policies in developing countries: What have we learned?," World Development, Elsevier, vol. 10(9), pages 701-708, September.
  3. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
  4. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America," MPRA Paper 13843, University Library of Munich, Germany.
  5. 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.
  6. Rodriguez, Carlos Alfredo, 1982. "The Argentine stabilization plan of December 20th," World Development, Elsevier, vol. 10(9), pages 801-811, September.
  7. Sebastian Edwards, 1991. "Stabilization and Liberalization Policies in Central and Eastern Europe: Lessons From Latin America," NBER Working Papers 3816, National Bureau of Economic Research, Inc.
  8. 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.
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