A Further Contribution towards Explaining Why Disinflation through Currency Pegging May Cause a Boom

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JournalJournal of International Money and Finance
DatePublished - Apr 2011
Issue number3
Volume30
Number of pages21
Pages (from-to)516-536
Original languageEnglish

Abstract

We revisit the question of why exchange-rate-based (ERB) disinflation is often expansionary. We use an analytical DGE model in discrete time with staggered wages. If the policy is unanticipated, and if the currency is pegged at the level it would have reached under unchanged policies, then a boom occurs. For preannounced ERB disinflation, our model also predicts a boom. The explanation for both is that when wages are staggered, wage-setters have to be forward-looking. Anticipating lower future inflation, they reduce wages before the change in the exchange rate, causing a favourable supply-side effect on output.

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