Copyrights to papers in the Duke Economics Working Paper Archive remain with the authors or their assignees. Archive users may download papers and produce them for their own personal use, but downloading of papers for any other activity, including reposting to other electronic bulletin boards or archives, may not be done without the written consent of the authors.

Duke Economics Working Paper #97-30

The Syndrome of Exchange-Rate-Based Stabilizations and the Uncertain Duration of Currency Pegs


Enrique G. Mendoza and Martín Uribe

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.

Keywords: Uncertain duration, credibility, fixed exchange rates, stabilization policy.

JEL: F31, F32, F41, F47

Retrieve document:

43 pages

  Help on downloading documents