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Fiscal Deficits, Exchange Rate Crises and Inflation

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Author Info
van Wijnbergen, Sweder

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Abstract

This paper extends earlier work on unsustainable monetary policies by endogenizing the regime switch that ultimately restores sustainability. Within this framework we analyze exchange rate based stabilization programs and shows how constraints on Central Bank borrowing during an exchange crisis influence timing and nature of the post-collapse equilibrium. Such constraints introduce non-neutralities; more restrictive pre-collapse credit policies increase the post-collapse inflation rate. External shocks can destroy consistency between fiscal programs and inflation targets, causing reserve losses, exchange rate changes and higher inflation. Balance of Payments crises are the mechanism through which fiscal imbalances translate into higher inflation rather than an alternative explanation of it. Copyright 1991 by The Review of Economic Studies Limited.

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Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 58 (1991)
Issue (Month): 1 (January)
Pages: 81-92
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Handle: RePEc:bla:restud:v:58:y:1991:i:1:p:81-92

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  1. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April. [Downloadable!] (restricted)
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  2. Obstfeld, Maurice, 1981. "Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1142-61, December. [Downloadable!] (restricted)
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  3. Kharas, Homi, 1984. "The Long-Run Creditworthiness of Developing Countries: Theory and Practice," The Quarterly Journal of Economics, MIT Press, vol. 99(3), pages 415-39, August. [Downloadable!] (restricted)
  4. Buiter, Willem H, 1984. "Fiscal Policy in Open, Interdependent Economies," CEPR Discussion Papers 28, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Flood, Robert P & Garber, Peter M, 1980. "An Economic Theory of Monetary Reform," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 24-58, February. [Downloadable!] (restricted)
  6. Blanco, Herminio & Garber, Peter M, 1986. "Recurrent Devaluation and Speculative Attacks on the Mexican Peso," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 148-66, February. [Downloadable!] (restricted)
  7. Buiter, Willem H, 1986. "Borrowing to Defend the Exchange Rate and the Timing and Magnitude of Speculative Attacks," CEPR Discussion Papers 95, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August. [Downloadable!] (restricted)
  9. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March. [Downloadable!] (restricted)
  10. Salant, Stephen W & Henderson, Dale W, 1978. "Market Anticipations of Government Policies and the Price of Gold," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 627-48, August. [Downloadable!] (restricted)
  11. Liviatan, Nissan, 1984. "Tight money and inflation," Journal of Monetary Economics, Elsevier, vol. 13(1), pages 5-15, January. [Downloadable!] (restricted)
  12. Willem H. Buiter, 1982. "Comment on T. J. Sargent and N. Wallace: "Some Unpleasant Monetarist Arithmetic"," NBER Working Papers 0867, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Drazen, Allan, 1985. "Tight money and inflation: Further Results," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 113-120, January. [Downloadable!] (restricted)
  14. Chamley, Christophe, 1985. "On a simple rule for the optimal inflation rate in second best taxation," Journal of Public Economics, Elsevier, vol. 26(1), pages 35-50, February. [Downloadable!] (restricted)
  15. Rudiger Dornbusch & Stanley Fischer, 1986. "Stopping Hyperinflations Past and Present," NBER Working Papers 1810, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Cited by:
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  1. Fiess, Norbert & Shankar, Rashmi, 2005. "Regime-switching in exchange rate policy and balance sheet effects," Policy Research Working Paper Series 3653, The World Bank. [Downloadable!]
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  2. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 1999. "Prospective deficits and the asian currency crisis," Policy Research Working Paper Series 2174, The World Bank. [Downloadable!]
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