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Losing Credibility: The Stabilization Blues
Author(s) -
Guidotti Pablo E.,
Végh Carlos A.
Publication year - 1999
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/1468-2354.00003
Subject(s) - credibility , inflation (cosmology) , currency , economics , negotiation , exchange rate , monetary economics , politics , devaluation , macroeconomics , keynesian economics , political science , physics , theoretical physics , law
In exchange rate‐based stabilization programs, credibility often follows a distinct time pattern. At first it rises as the highly visible nominal anchor provides a sense of stability and hopes run high for a permanent solution to fiscal problems. Later, as the domestic currency appreciates in real terms and the fiscal problems are not fully resolved, the credibility of the program falls, sometimes precipitously. This paper develops a political‐economy model that focuses on the evolution of credibility over time, and is consistent with the pattern just described. Inflation inertia and costly budget negotiations play a key role.