Stabilization Dynamics and Backward-Looking Contracts

Carlos Végh Gramont and Guillermo Calvo

No 1993/029, IMF Working Papers from International Monetary Fund

Abstract: Exchange rate-based stabilizations often result in an initial output expansion. One explanation for this phenomenon has been that, in the presence of inflation inertia, a reduction in the nominal interest rate causes the domestic real interest rate to fall, thus increasing aggregate demand. This paper reexamines this issue in the context of an intertemporal optimizing model. In contrast to previous results, the analysis shows that, if the intertemporal elasticity of substitution is smaller than the elasticity of substitution between traded and home goods, a permanent reduction in the rate of devaluation leads to a fall in aggregate demand.

Keywords: WP; aggregate demand; real interest rate; exchange rate; home goods; traded goods; home-goods sector; traded-goods wealth; real rate of interest; Consumption; Real interest rates; Real exchange rates; Inflation; Exchange rate adjustments (search for similar items in EconPapers)
Pages: 38
Date: 1993-03-01
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Citations: View citations in EconPapers (5)

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Journal Article: Stabilization dynamics and backward-looking contracts (1994)
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