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Exchange rate based disinflation, wage rigidity, and capital inflows : tradeoffs for Chile, 1977-81

  • Condon, Timothy
  • Corbo, Vittorio
  • De Melo, Jaime

Real exchange rate appreciation usually accompanies stabilization programs based on the exchange rate. One thing that causes the real exchange rate to appreciate is the capital inflows that follow liberalization of the capital account and the financial market. Capital inflows cause the exchange rate to appreciate in part because of the resulting increase in expenditures. This appreciation is exacerbated if there is some price rigidity, and if control of the money supply is only partial. All these conditions existed during Chile's experiment with exchange rate-based disinflation between 1978 and 1981. Simulating what might have been, the authors study how exchange rate based disinflation affects expenditures switching and reduction when wages are partially indexed in some segments of the labor market. The paper also shows the extent to which a more flexible rule on wage indexing would have offset the adverse impact of lower capital flows on protected sector employment.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 146.

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Date of creation: 28 Feb 1989
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Handle: RePEc:wbk:wbrwps:146
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  1. Svensson, Lars E O & Razin, Assaf, 1983. "The Terms of Trade and the Current Account: The Harberger-Laursen-Metzler Effect," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 97-125, February.
  2. Russell Davidson & James G. MacKinnon, 1980. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Working Papers 378, Queen's University, Department of Economics.
  3. R. Dornbusch, 1984. "External Debt, Budget Deficits and Disequilibrium Exchange Rates," Working papers 347, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Elhanan Helpman & Assaf Razin, 1985. "Exchange Rate Management: Intertemporal Tradoffs," NBER Working Papers 1590, National Bureau of Economic Research, Inc.
  5. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
  6. Dornbusch, Rudiger, 1982. "Stabilization policies in developing countries: What have we learned?," World Development, Elsevier, vol. 10(9), pages 701-708, September.
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