Disinflation and Fiscal Reform: A Neoclassical Perspective

Roberto Rigobon

No 8706, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: During the last two decades, many Latin American countries engaged in disinflation programs based on both exchange rate management and fiscal reforms. However, in most instances, part of the fiscal reform was delayed or not implemented completely, so the fiscal deficit increased and the program had to be abandoned. The aftermath of these programs is not encouraging, since most of these policies turned out to be failures, lowering reserves and causing higher inflation rates. Given this record, it is worth asking why governments start a disinflation program even though the fiscal equilibrium is not guaranteed. In this paper we show that, if the reform process is uncertain and inflation has welfare costs, the optimal exchange rate policy implies the initiation of a disinflation program at the announcement of the fiscal reform. Additionally, we show that even if there exists a possibility of a balance of payments crisis, it is still optimal to initiate a disinflation program. This means that, in this set up, avoiding the crisis with probability one is suboptimal. Finally, we show that it is optimal to engage in a sequence of stabilization programs until one of them is successful.

JEL-codes: F31 F32 (search for similar items in EconPapers)
Date: 2002-01
New Economics Papers: this item is included in nep-ifn
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Published as Rigobon, Roberto. "Disinflation And Fiscal Reform: A Neoclassical Perspective," Journal of International Economics, 2002, v57(2,Dec), 265-297.

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