February 1996

Comparing the Welfare Costs and the Initial Dynamics of Alternative Temporary Stabilization Policies

Martin Uribe


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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