Public sector layoffs, severance pay, and inflation in the small open economy

Because severance pay is worth 2–5 years of wages in many LDCs, public sector layoffs increase the fiscal deficit in the short run. Nevertheless, generous severance pay is not as serious a macroeconomic problem as generally thought. In the case where the fiscal deficit is financed by printing money, inflation is continuously lower under plausible conditions. When the government can borrow in world capital markets and layoffs reduce the present-value wage bill, there exists a sequence of bond sales and subsequent redemptions that guarantees continuously lower inflation. This result does not hold, however, if the reform lacks credibility.     

Financial repression,the new structuralists,and stabilization policy in semi-industrialized economies

This paper examines the short-and long-run effects of a variety of macroeconomic policies in a simple model where the curb market plays a pivotal role as the marginal supplier of loanable funds. It is found that financial liberalization may fail in the short-run and, contrary to the claims of the new structuralists, that the financial market repercussions of devaluation may be favorable. In evaluating any policy, the time horizon is critical. Short- and long-run multipliers may differ in sign in all cases, save that of a contraction in the stock of bank credit.     

Policy Rules and Monetarist Arithmetic

This note demonstrates the existence of an important equilibrium path overlooked in the literature on monetarist arithmetic. Pleasant monetarist arithmetic is possible when the interest‐elasticity of money demand exceeds unity. In this case, tight money may lead to a transitory increase in seigniorage, the retirement of government debt, and lower inflation in both the short run and the long run. The set of equilibrium paths is sensitive, however, to the form of the policy rule. Pleasant monetarist arithmetic is not an equilibrium if the policy rule fixes the share of the fiscal deficit financed by seigniorage. Both pleasant monetarist arithmetic and the tight‐money paradox are equilibrium paths when the government's commitment to low money growth is conditional on inflation remaining below its previous level.     

Devaluation, investment and growth in LDCs

This paper examines the short- and long-run effects of devaluation in a model where, following structuralist theories, investment is treated as output of a composite good produced by combining domestic and imported components in fixed proportions. Introducing investment goods of this type alters a number of results. Most notably, the Marshall-Lerner condition is neither necessary nor sufficient for an expansionary outcome and, under simple and plausible conditions, a devaluation may worsen the payments balance.     

Riding the wave: Monetary responses to aid surges in low-income countries

We focus on the management of highly persistent shocks to aid flows in the presence of currency substitution by the domestic private sector. Such shocks have beneficent long-run effects, but when currency substitution is high they can produce dramatic macroeconomic management problems in the short run. What is the appropriate mix of money and exchange rate targeting in such cases, and the role of temporary sterilization? We analyze these and related issues in an intertemporal optimizing model that allows a portion of aid to be devoted to reducing the government's seigniorage requirement. Our results show that a managed float, with little or no sterilization of increases in the monetary base, supports the smooth absorption of the increased aid without incurring higher inflation, higher real interest rates or overshooting of the real exchange rate.     

Fiscal inertia, donor credibility, and the monetary management of aid surges

Donors cannot pre-commit to support scaled-up public spending programs on a continuing basis, nor can governments credibly commit to curtail expenditure rapidly in the event that aid revenues contract. An aid boom may therefore be accompanied by a credibility problem. When this is the case, the absorb-and-spend strategy recommended by the IMF leads to capital flight, higher inflation, and large current account surpluses inclusive of aid. The right policy package combines a critical minimum degree of fiscal restraint with reverse sterilization.     

Foreign exchange bottlenecks,devaluation and inflation

Devaluation is unambiguously deflationary when foreign exchange earned by the export sector pays for additional imports of intermediate inputs and the criterion for a foreign exchange bottleneck is satisfied.     

The Taylor principle fights back,Part I

New Keynesian models with limited asset market participation assert that under plausible conditions higher real interest rates increase aggregate demand, the Taylor principle leads to indeterminacy, and passive policy ensures a unique equilibrium. These striking results stem from the assumption that the real wage is highly flexible. Relaxing this assumption slightly brings back the normal world where higher real interest rates reduce aggregate demand and where the Taylor principle is effectively necessary and sufficient for a unique, stable equilibrium.     

Resurrecting the weak credibility hypothesis in models of exchange-rate-based stabilization

We analyze how weak credibility affects the volatility of consumption spending in a model of exchange-rate-based stabilization that allows for both durable and nondurable goods. The inclusion of durables greatly improves the explanatory power of the weak credibility hypothesis. The hypothesis can account for the main qualitative properties of the boom–bust cycle provided the elasticity of durables expenditure with respect to Tobin's q is greater than the intertemporal elasticity of substitution. Moreover, the quantitative effects are very large. In numerical simulations based on conservative assumptions about the expenditure share of durables (20%) and wealth effects (none), aggregate consumption increases 17–22% and the real exchange rate appreciates 24–26% when the crawl decreases from 100% to zero for 3 years. In variants of the model that incorporate supply effects, the consumption boom is equally strong but appreciation of the real exchange rate rises to 30–40%.