The Syndrome of Exchange-Rate-Based Stabilizations and the Uncertain Duration of Currency Pegs
Year: 1997
Type: preprint
Abstract: This paper shows that some key stylized facts of exchange-rate-based stabilization plans can be explained by the uncertain duration of the plans themselves. Uncertain duration is modeled to reflect evidence showing that devaluation probabilities are higher when the plans are introduced and abandoned than in the period in between. If contingent-claims markets are incomplete, this uncertain duration distortion introduces temporary fiscal cuts with large wealth effects. Investment and employment are also distorted, and the resulting supply-side effects play a critical role. Stabilizations of uncertain duration entail large welfare costs, but they are preferred to persistent high inflation. Mexico's experience is examined in the light of these predictions.
DOI: 10.21034/dp.121
Authors: Enrique G. Mendoza, Martin Uribe
Language: English
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W4301043248