Munich Personal RePEc Archive

Exchange rate stabilization under imperfect credibility

Calvo, Guillermo and Vegh, Carlos (1991): Exchange rate stabilization under imperfect credibility.

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Abstract

This paper analyzes stabilization policy under predetermined exchange rates in a cash-in-advance, staggered-prices model. Under full credibility, a reduction in the rate of devaluation results in an immediate and permanent reduction in the inflation rate, with no effect on output or consumption. In contrast, a non-credible stabilization results in an initial expansion of output, followed by a later recession. The inflation rate of home goods remains above the rate of devaluation throughout the program, thus resulting in a sustained real exchange rate appreciation.

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