Fix vs. Float: Evaluating the Transition to a Sustainable Equilibrium in Bolivia

IMF Working Papers, February 25, 2022

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Canonical URL: Fix vs. Float: Evaluating the Transition to a Sustainable Equilibrium in Bolivia

Bolivia achieved noteworthy success over the past 15 years in raising incomes, reducing poverty, and maintaining macroeconomic stability by deploying commodity revenues to finance transfers, public investment, and state-led development, using an exchange rate peg as a policy anchor.
With the end of the commodity boom in 2014, fiscal deficits have grown and reserves have fallen.
One route to restoring long-run sustainability would be to combine fiscal consolidation with a switch to a floating exchange rate.
A preference for maintaining the peg could be accommodated with adjustments elsewhere in the policy framework.
The study concludes that continued adherence to a fixed-rate regime, while not optimal, is feasible, if supported by a larger fiscal effort.

Employs a detailed dynamic stochastic general equilibrium model of the Bolivian economy.
Assesses long-run sustainability and relative benefits of alternative policy combinations.
Calculates optimal adjustment paths for the transition from the present situation to the steady state.
Keywords and analytical concepts used: linear time iteration, transition path, utility function, time consistency, speculative attack, open economy.

Scenario A: Combine fiscal consolidation with a switch to a floating exchange rate to restore long-run sustainability.
Scenario B: Maintain the conventional peg, but implement larger fiscal adjustments and supporting policy framework changes to preserve sustainability.
Comparative takeaway: Floating plus fiscal consolidation is the preferable (optimal) route; maintaining the peg is feasible but requires a larger fiscal effort.

Pursue fiscal consolidation to address growing fiscal deficits and declining reserves post-2014.
If policymakers prefer to keep the exchange rate peg, plan for larger fiscal adjustments and complementary policy changes to achieve sustainability.
Consider the transition paths computed by the model to manage the move from the current situation to the steady state while minimizing welfare losses and vulnerability to shocks.

Subject: Conventional peg, Exchange rate arrangements, Exchange rate flexibility, Fiscal policy, Floating exchange rates, Foreign exchange, Government debt management, Public financial management (PFM)
Keywords: Bolivia, commodity revenue, Conventional peg, Exchange rate arrangements, Exchange rate flexibility, fixed exchange rate, Floating exchange rates, Government debt management, inflation target, linear time iteration, long-run sustainability, open economy, speculative attack, time consistency., transition path, utility function

IMF Working Paper — Fix vs. Float: Evaluating the Transition to a Sustainable Equilibrium in Bolivia (February 25, 2022).