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Intertemporal substitution in a monetary framework : evidence from Chile and Mexico


  • Arrau, Patricio


This paper estimates a monetary Euler system of a utility-maximizing representative consumer from two inflationary Latin American countries: Chile in the late seventies and Mexico in the early eighties. The results show that money is necessary to get reasonable parameters of the utility function. For both countries, tests of the overidentifying restrictions are satisfactory at usual levels of significance and estimates for the intertemporal elasticity of substitution are greater than one. The results indicate that velocity sensitivity to the nominal interest rate is lower for Chile than for Mexico, but this difference could be explained by a model of currency substitution. More important, a model of currency substitution may be the appropriate way to explain the monetary puzzle observed in Mexico after the stabilization attempt of late 1987. Despite the fact that inflation was sharply (and permanently) reduced, velocity did not go down. The model of currency substitution suggests that a good way to hedge against discrete devaluation would be to increase liquidity in foreign - not domestic - currency.

Suggested Citation

  • Arrau, Patricio, 1990. "Intertemporal substitution in a monetary framework : evidence from Chile and Mexico," Policy Research Working Paper Series 549, The World Bank.
  • Handle: RePEc:wbk:wbrwps:549

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    References listed on IDEAS

    1. Calvo, Guillermo A, 1986. "Temporary Stabilization: Predetermined Exchange Rates," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1319-1329, December.
    2. Bernanke, Ben, 1985. "Adjustment costs, durables, and aggregate consumption," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 41-68, January.
    3. Calvo, Guillermo A., 1985. "Currency substitution and the real exchange rate: the utility maximization approach," Journal of International Money and Finance, Elsevier, vol. 4(2), pages 175-188, June.
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    Cited by:

    1. Reinhart, Carmen & Vegh, Carlos, 1994. "Inflation stabilization in chronic inflation countries: The empirical evidence," MPRA Paper 13689, University Library of Munich, Germany.
    2. Emilio Espino & Martín González Rozada, 2015. "On the Implications of Taxation for Investment, Savings and Growth: Evidence from Brazil, Chile and Mexico," IDB Publications (Working Papers) 89116, Inter-American Development Bank.
    3. Emilio Espino & Martín González Rozada, 2013. "Normative Fiscal Policy and Growth: Some Quantitative Implications for the Chilean Economy," IDB Publications (Working Papers) 4648, Inter-American Development Bank.
    4. 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.
    5. Arrau, Patricio & van Wijnbergen, Sweder, 1991. "Intertemporal substitution, risk aversion, and private savings in Mexico," Policy Research Working Paper Series 682, The World Bank.
    6. Reinhart, Carmen & Ostry, Jonathan, 1991. "Private Saving and Terms of Trade Shocks," MPRA Paper 13716, University Library of Munich, Germany.
    7. Patricio Arrau & Jorge Quiroz & Rómulo Chumacero, 1992. "Ahorro Fiscal y Tipo de Cambio Real," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 29(88), pages 349-386.
    8. Villagómez Amezcua, Alejandro, 1994. "El ahorro privado y la tasa de interés en México: 1963-1991," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 9(1), pages 43-60.
    9. Arrau, Patricio & de Gregorio, Jose, 1991. "Financial innovation and money demand : theory and empirical implementation," Policy Research Working Paper Series 585, The World Bank.


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