Hyperinflation and Stabilization: Cagan Revisited
Using a variant of the Cagan 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 Drazen and Helpman (1990) by including a stochastic budgetary process and using option pricing theory. It uses parameter values of the semi-elasticity of demand for money to provide estimates of the maximum viable real deficit.
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- 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.
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- 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.
- Loungani, Prakash & Sheets, Nathan, 1997.
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- Prakash Loungani & Nathan Sheets, 1995. "Central bank independence, inflation and growth in transition economies," International Finance Discussion Papers 519, Board of Governors of the Federal Reserve System (U.S.).
- Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, 07.
- 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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