The Business Cycle Associated with Exchange Rate-Based Stabilizations

Kiguel and Liviatan, 1992.

This article examines the effects of disinflation on economic activity in countries characterized by chronic inflation. Such countries have a long history of inflation at rates exceeding those in industrial countries as well as labor and capital markets that have adjusted to function in an inflationary environment. A sample of disinflation programs in several Latin American countries and in Israel demonstrates that stabilization efforts in countries with chronic inflation often do not induce the usual Phillips curve tradeoff in the medium run. Specifically, stabilization programs that use the exchange rate as the main nominal anchor are often associated with a business cycle that begins with a boom and ends with a recession.