Abstract:
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 substitution ERB programs outperform MBR programs.
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