Resurrecting the Weak Credibility Hypothesis in Models of Exchange-Rate-Based Stabilization

Edward Buffie () and Manoj Atolia ()
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Edward Buffie: Department of Economics, Indiana University

No wp2009_01_03, Working Papers from Department of Economics, Florida State University

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 12-28% during the low-crawl phase and the real exchange rate appreciates 24-26%. 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)
Pages: 57
Date: 2006-06, Revised 2007-08
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Citations: View citations in EconPapers (3)

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https://coss.fsu.edu/econpapers/wpaper/wp2009_01_03.pdf First version, 2007-08 (application/pdf)

Related works:
Journal Article: Resurrecting the weak credibility hypothesis in models of exchange-rate-based stabilization (2012)
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