The Syndrome of Exchange-Rate-Based Stabilizations and the Uncertain Duration of Currency Pegs

Duke Economics Working Paper No. 97-30

44 Pages Posted: 13 Aug 1998

See all articles by Enrique G. Mendoza

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: August 1, 1997

Abstract

This paper shows that some key stylized facts of exchange-rate-based stabilization plans can be explained by the uncertain duration of the plans themselves. Uncertain duration is modeled to reflect evidence showing that devaluation probabilities are higher when the plans are introduced and abandoned than in the period in between. If contingent-claims markets are incomplete, this uncertain duration distortion introduces temporary fiscal cuts with large wealth effects. Investment and employment are also distorted, and the resulting supply-side effects play a critical role. Stabilizations of uncertain duration entail large welfare costs, but they are preferred to persistent high inflation. Mexico's experience is examined in the light of these predictions.

JEL Classification: F31, F32, F41, F47

Suggested Citation

Mendoza, Enrique G. and Uribe, Martin, The Syndrome of Exchange-Rate-Based Stabilizations and the Uncertain Duration of Currency Pegs (August 1, 1997). Duke Economics Working Paper No. 97-30, Available at SSRN: https://ssrn.com/abstract=114730 or http://dx.doi.org/10.2139/ssrn.114730

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

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University of Pennsylvania ( email )

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HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

Martin Uribe (Contact Author)

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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United States

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