Fiscal Deficits, Exchange Rate Crises and Inflation

Sweder van Wijnbergen

No 2130, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The analysis focuses on the government budget constraint and the resolution of inconsistent implications of different policy instruments under that constraint. We show how, under floating exchange rates, external shocks or internal structural reforms may cause jumps in inflation and the exchange rate through their impact on the government budget. In order to achieve a sustainable reduction in inflation an exchange rate freeze or crawling peg is shown to require restrictions not only on domestic credit, but also on the rate of increase in interest-bearing public debt. We endogenize regime collapse by introducing rational speculation against the central bank, and show that if an exchange rate freeze collapses, post-collapse inflation will exceed the rate prevailing before the freeze started.

Date: 1987-01
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Published as Review of Economic Studies, Vol. 58, no. 193 (1991): 81-92.

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Journal Article: Fiscal Deficits, Exchange Rate Crises and Inflation (1991)
Working Paper: Fiscal Deficits, Exchange Rate Crises and Inflation (1985)
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