Devaluation and Monetary Policy in Developing Countries: A General Equilibrium Model for Economies Facing Financial Constraints

Liliana Rojas-Suarez

IMF Staff Papers, 1987, vol. 34, issue 3, 439-470

Abstract: The short-run response of output to devaluation and monetary policies is investigated for economies where firms are constrained to finance in advance their working capital by borrowing solely from domestic banks. It is shown that in contrast with traditional theories, but in accordance with recent theoretical and empirical analyses for developing countries, an anticipated devaluation or an anticipated decrease in the level of the exogenous component of money might result in a short-run output contraction even if prices fully adjust to clear markets. In addition, the paper analyses how output responds when a devaluation is unanticipated or when agents cannot distinguish between temporary and permanent monetary shocks.

Date: 1987
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