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Fixed Exchange Rates, Inflation and Macroeconomic Discipline

  • Sebastian Edwards
  • Fernando J. Losada

We use data from Guatemala and Honduras to investigate some implications of the Purchasing Power Parity theory over the long run. In particular, we address two questions. First, to what extent did the fixed exchange rate regime impose macroeconomic discipline on these countries. Second, what was the impact of terms of trade shocks and growth differentials on inflation rate differentials between those countries and the United States. We found that the fixed parities regime worked properly until the mid-1970s, providing some constraint on central bank behavior. However, the evidence suggests that the fixed exchange rate system was not sufficient to avoid inflation outbursts and balance of payments crises. Specifically, it was unable to accommodate large negative terms of trade shocks in the late 1970s and early 1980s.

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File URL: http://www.nber.org/papers/w4661.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4661.

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Date of creation: Feb 1994
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Handle: RePEc:nbr:nberwo:4661
Note: IFM
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  1. Shantayanan Devarajan & Dani Rodrik, 1991. "Do the Benefits of Fixed Exchange Rates Outweigh Their Costs? The Franc Zone in Africa," NBER Working Papers 3727, National Bureau of Economic Research, Inc.
  2. Alan C. Stockman, 1993. "International Transmission under Bretton Woods," NBER Chapters, in: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, pages 317-356 National Bureau of Economic Research, Inc.
  3. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
  4. Svensson, Lars E O, 1994. "Fixed Exchange Rates as a Means to Price Stability: What Have We Learned?," CEPR Discussion Papers 872, C.E.P.R. Discussion Papers.
  5. Maurice Obstfeld, 1982. "Can We Sterilize? Theory and Evidence," NBER Working Papers 0833, National Bureau of Economic Research, Inc.
  6. Bruno, M., 1991. "High Inflation and the Nominal Anchors of an Open Economy," Princeton Studies in International Economics 183, International Economics Section, Departement of Economics Princeton University,.
  7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  8. Peter Montiel & Bijan B. Aghevli & Mohsin S. Khan, 1991. "Exchange Rate Policy in Developing Countries; Some Analytical Issues," IMF Occasional Papers 78, International Monetary Fund.
  9. Steven B. Kamin, 1991. "Exchange rate rules in support of disinflation programs in developing countries," International Finance Discussion Papers 402, Board of Governors of the Federal Reserve System (U.S.).
  10. Swoboda, Alexander K, 1978. "Gold, Dollars, Euro-Dollars, and the World Money Stock under Fixed Exchange Rates," American Economic Review, American Economic Association, vol. 68(4), pages 625-42, September.
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