NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Fiscal Deficits, Exchange Rate Crises and Inflation

Sweder van Wijnbergen

NBER Working Paper No. 2130
Issued in 1987
NBER Program(s):   ITI   IFM

The analysis focuses on the government budget constraint and the resolution of inconsistent implications of different policy instruments under that constraint. We show how, under floating exchange rates, external shocks or internal structural reforms may cause jumps in inflation and the exchange rate through their impact on the government budget. In order to achieve a sustainable reduction in inflation an exchange rate freeze or crawling peg is shown to require restrictions not only on domestic credit, but also on the rate of increase in interest-bearing public debt. We endogenize regime collapse by introducing rational speculation against the central bank, and show that if an exchange rate freeze collapses, post-collapse inflation will exceed the rate prevailing before the freeze started.

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Document Object Identifier (DOI): 10.3386/w2130

Published: Review of Economic Studies, Vol. 58, no. 193 (1991): 81-92.

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