This paper compares the welfare costs and initial dynamics of three alternative
inflation stabilization policies using the staggered price model with imperfect
credibility and currency substitution developed by Calvo and Vegh (1990). In
addition to the policies analyzed by Calvo and Vegh (1990)--a temporary
exchange-rate based stabilization program (ERB) and a temporary money based
program (MB)--this paper considers a third stabilization policy consisting of a
temporary money based program with initial reliquefication--i.e., an initial
once-and-for-all increase in the money supply--that keeps the nominal and real
exchange rate from appreciating on impact (MBR). Simulation results suggest
that the welfare costs associated with ERB and MBR programs are lower than
those generated by MB programs. This seems to be the case even for highly
temporary programs and for economies with low degree of currency substitution.
ERB and MBR programs produce similar welfare costs except in two cases; when
the policy change is very temporary, MBR programs do better, while for high
values of the elasticity of currency substitutmitted efficiently within the
bank-based German system of corporate governance.
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Last update: July 19, 2001