Resurrecting the weak credibility hypothesis in models of exchange-rate-based stabilization

Edward F. Buffie and Manoj Atolia ()

European Economic Review, 2012, vol. 56, issue 3, 361-372

Abstract: We analyze how weak credibility affects the volatility of consumption spending in a model of exchange-rate-based stabilization that allows for both durable and nondurable goods. The inclusion of durables greatly improves the explanatory power of the weak credibility hypothesis. The hypothesis can account for the main qualitative properties of the boom–bust cycle provided the elasticity of durables expenditure with respect to Tobin's q is greater than the intertemporal elasticity of substitution. Moreover, the quantitative effects are very large. In numerical simulations based on conservative assumptions about the expenditure share of durables (20%) and wealth effects (none), aggregate consumption increases 17–22% and the real exchange rate appreciates 24–26% when the crawl decreases from 100% to zero for 3 years. In variants of the model that incorporate supply effects, the consumption boom is equally strong but appreciation of the real exchange rate rises to 30–40%.

Keywords: Credibility; Exchange-rate-based stabilization; Durables (search for similar items in EconPapers)
JEL-codes: E31 E63 F41 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Resurrecting the Weak Credibility Hypothesis in Models of Exchange-Rate-Based Stabilization (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:56:y:2012:i:3:p:361-372

DOI: 10.1016/j.euroecorev.2011.10.004

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