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Exchange-Rate-Based Stabilization with Endogenous Fiscal Response

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  • Talvi, Ernesto

Abstract

In the context of a perfect foresight, intertemporal optimizing, cash-in-advance model, this paper studies the dynamics of an inconsistent exchange rate-based stabilization policy that fixes the exchange rate without an underlying fiscal adjustment to ensure that the exchange rate policy is sustainable in the long run. The perception that the exchange rate policy is temporary leads to an initial expansion in consumption, and, since the model allows for distortionary taxes on consumption, to an endogenous increase in tax revenues large enough to eliminate the ex-ante fiscal deficit. This paper was prepared for the 8th NBER Inter-American Seminar, held in Bogotá, Colombia in November 1995.

Suggested Citation

  • Talvi, Ernesto, 1996. "Exchange-Rate-Based Stabilization with Endogenous Fiscal Response," IDB Publications (Working Papers) 6211, Inter-American Development Bank.
    • Handle: RePEc:idb:brikps:6211
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    References listed on IDEAS

    as
    1. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June.
    2. Reinhart, Carmen & Vegh, Carlos, 1994. "Inflation stabilization in chronic inflation countries: The empirical evidence," MPRA Paper 13689, University Library of Munich, Germany.
    3. Kiguel, Miguel A & Liviatan, Nissan, 1992. "The Business Cycle Associated.with Exchange Rate-Based Stabilizations," The World Bank Economic Review, World Bank, vol. 6(2), pages 279-305, May.
    4. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June.
    5. 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.
    6. Calvo, Guillermo A, 1986. "Temporary Stabilization: Predetermined Exchange Rates," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1319-1329, December.
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    Cited by:

    1. Gavin, Michael & Hausmann, Ricardo & Talvi, Ernesto, 1997. "Saving Behavior in Latin America: Overview and Policy Issues," IDB Publications (Working Papers) 6204, Inter-American Development Bank.

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