The Behavior of Real Interest Rates in Exchange-Rate Based Stabilization Programs

Author/Editor:

Pierre-Richard Agénor

Publication Date:

June 1, 1994

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:

This paper examines the behavior of real interest rates in exchange-rate based stabilization programs. The analysis is based on a model with imperfect capital mobility and optimizing agents. A permanent reduction in the devaluation rate is first shown to have an ambiguous effect on real interest rates on impact. The analysis is then extended to consider a stabilization program characterized by an initial reduction in the rate of devaluation of the nominal exchange rate, and the announcement of a future increase in income taxes. The impact effect on real interest rates is shown to depend upon the degree of credibility of the announcement. Real interest rates may fall if agents do not believe that taxes will be raised, and rise if the future tax reform is sufficiently credible.

Series:

Working Paper No. 94/75

Subject:

English

Publication Date:

June 1, 1994

ISBN/ISSN:

9781451849660/1018-5941

Stock No:

WPIEA0751994

Format:

Paper

Pages:

46

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