Sticky Inflation and the Real Effects of Exchange Rate Based Stabilization
IMF Working Papers, July 1, 2003
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Bibliographic details
- Authors: Oya Celasun
- Published: July 1, 2003
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451857054.001
Overview and research question
- Author: Oya Celasun
- Publication date: July 1, 2003
- Series: Working Paper No. 2003/151
- Pages: 34
- Issue: 151
- Volume: 2003
- DOI: https://doi.org/10.5089/9781451857054.001
- Stock No: WPIEA1512003
- ISBN: 9781451857054
- ISSN: 1018-5941
- Core question: How does partial inflation stickiness affect the real dynamics (boom-recession cycle and real exchange rate appreciation) associated with exchange rate-based inflation stabilization (ERBS) when stabilization plans lack credibility?
Empirical findings
- ERBS policies are associated with:
- a boom-recession cycle in economic activity
- sustained real exchange rate appreciation
- Empirical test performed for Mexico and Turkey (two countries that have experienced ERBS).
- Pricing behavior result:
- The forward- and backward-looking components of inflation weigh approximately equally in pricing behavior.
- Conclusion: inflation is partially sticky (i.e., neither perfectly forward-looking nor purely backward-looking).
Theoretical implications developed in the paper
- Context: lack-of-credibility models of ERBS typically assume perfectly forward-looking pricing and no inflation stickiness, explaining slow inflation decline via a consumption boom driven by perceived temporariness of ERBS.
- With partial inflation stickiness:
- The persistence of the consumption boom predicted by the lack-of-credibility model is significantly reduced.
- Partial stickiness helps explain the recession in the late phase of the stabilization.
Key themes and concepts
- Business cycles
- Consumption dynamics
- Credibility of stabilization plans
- Disinflation and inflation stabilization
- Inflation stickiness and inflation persistence
- Exchange rate adjustments and real exchange rates
- Excess demand and nontradables inflation dynamics
- Application focus: Mexico, Turkey
Principal conclusions
- Empirical evidence rejects the assumption of perfectly forward-looking pricing in the examined ERBS episodes; instead, inflation dynamics combine forward- and backward-looking behavior roughly equally.
- Introducing partial inflation stickiness into lack-of-credibility ERBS models materially alters predicted real effects:
- It reduces the duration and persistence of consumption booms.
- It contributes to an explanation for the downturn (recession) observed in the late phase of ERBS episodes.
Implied source: IMF Working Papers — Sticky Inflation and the Real Effects of Exchange Rate Based Stabilization, Oya Celasun, July 1, 2003, Working Paper No. 2003/151, DOI: https://doi.org/10.5089/9781451857054.001
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- Sticky Inflation and the Real Effects of Exchange Rate-Based Stabilization - WP/03/151