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Stabilization Dynamics and Backward-Looking Contracts

Author

Listed:
  • Mr. Guillermo Calvo
  • Mr. Carlos A. Végh Gramont

Abstract

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.

Suggested Citation

  • Mr. Guillermo Calvo & Mr. Carlos A. Végh Gramont, 1993. "Stabilization Dynamics and Backward-Looking Contracts," IMF Working Papers 1993/029, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:1993/029
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    References listed on IDEAS

    as
    1. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April.
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