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In this paper, I focus on a phenomenon that has not received much attention in the literature, namely that the mere expectation of foreign direct investment (FDI) incentivizes long‐maturity investment projects by domestic residents, and a... more
In this paper, I focus on a phenomenon that has not received much attention in the literature, namely that the mere expectation of foreign direct investment (FDI) incentivizes long‐maturity investment projects by domestic residents, and a Sudden Stop when expectations are frustrated. Long‐maturity investment projects enhance productivity but increase the economy's vulnerability to Sudden Stop. The discussion is framed in a context in which a Sudden Stop follows a surge of capital inflows (Sudden Flood), and FDI is concentrated on ongoing projects. A Sudden Stop episode can trigger a fire sale of long‐term assets, output collapse, and welfare redistribution, which is another ignored phenomenon.
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ABSTRACT
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ABSTRACT In high inflation countries, policymakers often end up paying interest on part of the money supply. Higher interest rates on money have been used as a disinflationary policy. This paper analyzes the effectiveness of such a policy... more
ABSTRACT In high inflation countries, policymakers often end up paying interest on part of the money supply. Higher interest rates on money have been used as a disinflationary policy. This paper analyzes the effectiveness of such a policy in the context of a closed-economy, staggered-prices model. Both a permanent and a temporary rise in the interest rate on money provoke an inflation at the expense of a recession. When the rise is temporary, however, the initial inflation slowdown is eventually followed by an upsurge of inflation over the level prevailing before the policy was implemented. Copyright 1996 by Royal Economic Society.
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Research Interests: Economics, Monetary Economics, Developing Countries, Monetary Policy, Social Science Research Network, and 13 moreDeveloping Country, Inflation, Rational Expectations, Exchange rate, Currency, Quantity Theory of Money, Real Exchange Rate, Inflation Cosmology, Money Supply, Negative Nominal Interest Rate, Quantity Theory, Currency Substitution, and substitution (logic)
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... study of interest rate targeting has faced the problem that it results in price level indeterminacy under flexible prices (Sargent and Wallace 1981), or in multiple inflation rate equilibria ... 6. In Calvo and Vegh (199Oa), we study... more
... study of interest rate targeting has faced the problem that it results in price level indeterminacy under flexible prices (Sargent and Wallace 1981), or in multiple inflation rate equilibria ... 6. In Calvo and Vegh (199Oa), we study the predetermined exchange rate case. ...
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ABSTRACT High and persistent inflation has been one of the distinguishing macroeconomic characteristics of many developing countries since the end of World War II. Countries afflicted by chronic inflation, however, have not taken their... more
ABSTRACT High and persistent inflation has been one of the distinguishing macroeconomic characteristics of many developing countries since the end of World War II. Countries afflicted by chronic inflation, however, have not taken their fate lightly and have engaged in repeated stabilization attempts. More often than not, stabilization plans have failed. The end of stabilizations — particularly those which rely on a pegged exchange rate — has often involved dramatic balance-of-payments crises. As stabilization plans come and go, a large literature has developed trying to document the main empirical regularities and to understand the key issues involved. This chapter undertakes a critical review and evaluation of the literature related to inflation stabilization policies and balance-of-payments crises in developing countries.The chapter begins by trying to rationalize the existence of chronic inflation in a world of rational agents. It then offers an empirical analysis of the main stylized facts associated with stopping chronic inflation. It is shown that the real effects of disinflation depend on the nominal anchor which is used. Exchange-rate-based stabilizations lead to an initial output and consumption boom — which is particularly evident in the behavior of durable goods — real exchange rate appreciation, and current account deficits. The contractionary costs typically associated with disinflation emerge only later in the program. In contrast, in money-based stabilizations, the contraction occurs in the beginning of the program. The chapter then proceeds to review several explanations for these puzzling phenomena, emphasizing the real effects of lack of credibility, inflation inertia, and consumption cycles generated by durable goods purchases.The chapter also documents the fact that most exchange-rate-based stabilizations end up in balance-of-payments crises. The Mexican crisis of December 1994 brought back to life some of the key questions: Do exchange-rate-based stabilizations sow the seeds of their own destruction by unleashing “unsustainable” real exchange rate appreciations and current account deficits? Or are credibility problems and self-fulfilling prophecies at the root of these crises? The remainder of the chapter is devoted to analyzing the main ideas behind this unfolding literature.
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Page 1. INFLATION STABILIZATION AND NOMINAL ANCHORS GUILLERMO A. CALVO and CARLOS A. VEGH* This paper analyzes the choice of a nominal anchor in disinflation programs in chronic inflation countries. Both theory and evidence suggest... more
Page 1. INFLATION STABILIZATION AND NOMINAL ANCHORS GUILLERMO A. CALVO and CARLOS A. VEGH* This paper analyzes the choice of a nominal anchor in disinflation programs in chronic inflation countries. Both theory and evidence suggest several conclusions. ...
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Research Interests: Economics, Economic policy, Numerical Simulation, Social Science Research Network, External Debt, and 12 morePublic Debt, United States, Debt, Economic Model, Non Banking Financial Institutions, Inflation Cosmology, Psychological Maturity, Indexation, Debt Management, Negative Nominal Interest Rate, Government Debt, and Debt to GDP Ratio
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During the past few years, many emerging market countries have suffered severe currency and banking crises. A popular view blames fixed exchange rates--specifically, soft pegs--for these financial meltdowns. Indeed, fixed exchange rates... more
During the past few years, many emerging market countries have suffered severe currency and banking crises. A popular view blames fixed exchange rates--specifically, soft pegs--for these financial meltdowns. Indeed, fixed exchange rates have been so demonized by some adherents to that view that the only alternative for emerging markets seems to be to allow their currencies to float. Other analysts draw a very different lesson from these events. After all, a country cannot have a currency crisis if it does not have a domestic currency in the first place; firms, banks, and households are immune to currency mismatches if all assets and liabilities are denominated in the same currency. The obvious policy recommendation that follows is that full dollarization may, in some cases, be desirable. Some observers forecast that intermediate exchange rate regimes will vanish, as countries move toward corner solutions--with freely-floating exchange rate regimes at one end, hard pegs, such as curr...
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Standard real models predict that a permanent increase in oil prices would result in a current account surplus. This is due to the fact that investment falls while saving remains unchanged. This paper shows that if currency substitution... more
Standard real models predict that a permanent increase in oil prices would result in a current account surplus. This is due to the fact that investment falls while saving remains unchanged. This paper shows that if currency substitution is introduced into the analysis, the same shock could cause a current account deficit. Furthermore, the higher the dependence of the economy on oil, the larger would be the deficit. The presence of foreign money makes it optimal for the public to decrease saving following the terms of trade deterioration. The fall in saving could be larger than the decline in investment.
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This paper examines optimal monetary policy under uncertainty in a context in which policymakers are able to make credible policy commitments. The authors study an optimal taxation problem of minimizing the social cost of financing a... more
This paper examines optimal monetary policy under uncertainty in a context in which policymakers are able to make credible policy commitments. The authors study an optimal taxation problem of minimizing the social cost of financing a stochastic and exogenous level of government transfers. Since, in the basic model, the welfare costs of inflation derive only from expected inflation, the optimal
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... Thus, the price level at period 0 is assumed to be a predetermined variable. 11 Hence, the only decision faced by government in period 0 (government 0, for short) is to choose the maturity structure of the given initial stock of... more
... Thus, the price level at period 0 is assumed to be a predetermined variable. 11 Hence, the only decision faced by government in period 0 (government 0, for short) is to choose the maturity structure of the given initial stock of public debt. ...
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This paper analyzes stabilization policy under predetermined exchange rates in a cash-in-advance, staggered-prices model. Under full credibility, a reduction in the rate of devaluation results in an immediate and permanent reduction in... more
This paper analyzes stabilization policy under predetermined exchange rates in a cash-in-advance, staggered-prices model. Under full credibility, a reduction in the rate of devaluation results in an immediate and permanent reduction in the inflation rate, with no effect on ...