The Business Cycle Associated with Exchange Rate-Based Stabilizations

This article examines the effects of disinflation on economicactivity in countries characterized by chronic inflation. Suchcountries have a long history of inflation at rates exceedingthose in industrial countries as well as labor and capital marketsthat have adjusted to function in an inflationary environment.A sample of disinflation programs in several Latin Americancountries and in Israel demonstrates that stabilization effortsin countries with chronic inflation often do not induce theusual Phillips curve tradeoff in the medium run. Specifically,stabilization programs that use the exchange rate as the mainnominal anchor are often associated with a business cycle thatbegins with a boom and ends with a recession. Stabilizationprograms that use money supply as the nominal anchor generallyinduce the expected Phillips curve result: lower inflation isaccompanied by a recession after the program is implemented.