Sticky Inflation and the Real Effects of Exchange Rate Based Stabilization

 
Author/Editor: Celasun, Oya
 
Publication Date: July 01, 2003
 
Electronic Access: Free Full text (PDF file size is 989KB).
Use the free Adobe Acrobat Reader to view this PDF file

 
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: Exchange rate-based inflation stabilization (ERBS) policies are associated with a boom-recession cycle in economic activity and sustained real exchange rate appreciation. A class of models in the literature has explained these empirical regularities with the lack of credibility of the stabilization plans. The lack-of-credibility models typically assume perfectly forward-looking pricing behavior without inflation stickiness and attribute the slow decline in inflation to the consumption boom that occurs due to the perceived temporariness of the ERBS policy. This paper tests the empirical validity of forward-looking pricing behavior in Mexico and Turkey, two countries which have experienced ERBS. It finds that the forward- and backward-looking components of inflation weigh approximately equally in pricing behavior, and therefore, that inflation is partially sticky. The paper then develops the theoretical implications of partial inflation stickiness in a lack of credibility model of ERBS and concludes that the presence of stickiness significantly reduces the persistence of the consumption boom predicted by the model, but helps to explain the recession in the late phase of the stabilization.
 
Series: Working Paper No. 03/151
Subject(s): Inflation | Mexico | Turkey | Exchange rate stability

Author's Keyword(s): Disinflation | Inflation Persistence | Credibility | Mexico | Turkey
 
English
Publication Date: July 01, 2003
ISBN/ISSN: 1934-7073 Format: Paper
Stock No: WPIEA1512003 Pages: 33
Price:
US$15.00 (Academic Rate:
US$15.00 )
 
 
Please address any questions about this title to publications@imf.org