Sticky Inflation and the Real Effects of Exchange Rate Based Stabilization

July 1, 2003

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Format: Chicago

Oya Celasun. Sticky Inflation and the Real Effects of Exchange Rate Based Stabilization, (USA: International Monetary Fund, 2003) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Exchange rate-based inflation stabilization (ERBS) policies are associated with a boom-recession cycle in economic activity and sustained real exchange rate appreciation. A class of models in the literature has explained these empirical regularities with the lack of credibility of the stabilization plans. The lack-of-credibility models typically assume perfectly forward-looking pricing behavior without inflation stickiness and attribute the slow decline in inflation to the consumption boom that occurs due to the perceived temporariness of the ERBS policy. This paper tests the empirical validity of forward-looking pricing behavior in Mexico and Turkey, two countries which have experienced ERBS. It finds that the forward- and backward-looking components of inflation weigh approximately equally in pricing behavior, and therefore, that inflation is partially sticky. The paper then develops the theoretical implications of partial inflation stickiness in a lack of credibility model of ERBS and concludes that the presence of stickiness significantly reduces the persistence of the consumption boom predicted by the model, but helps to explain the recession in the late phase of the stabilization.

Subject: Business cycles, Consumption, Economic growth, Exchange rate adjustments, Exchange rate devaluation, Exchange rates, Foreign exchange, Inflation, National accounts, Prices, Real exchange rates

Keywords: Business cycles, Consumption, Credibility, Disinflation, Excess demand, Exchange rate, Exchange rate adjustments, Exchange rate devaluation, Exchange rates, Inflation, Inflation coefficient, Inflation dynamics, Inflation equation, Inflation Persistence, Inflation stabilization, Inflation stickiness, Mexico, Nontradables inflation dynamics, Price level, Rate of exchange, Rate of exchange rate depreciation, Real exchange rates, Stabilization plan, Structural inflation, Turkey, WP

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2003/151
Stock No:

WPIEA1512003
ISBN:

9781451857054
ISSN:

1018-5941

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