NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Money-Based versus Exchange Rate-Based Stabilization with Endogenous Fiscal Policy

Aaron Tornell, Andres Velasco

NBER Working Paper No. 5300
Issued in October 1995
NBER Program(s):   IFM

We present a standard intertemporal model in which fiscal policy is determined by an optimizing but non-benevolent fiscal authority. If the fiscal authority is impatient, a money-based stabilization provides more fiscal discipline and higher welfare for the representative agent than does an exchange rate-based stabilization. Data for Latin American stabilizations in the last quarter-century seem to confirm the notion that stabilizing by using money rather than the exchange rate helps induce politicians to reduce the fiscal deficit.

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