• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

'Less than credible stabilisation will not eliminate inertia and will generate real exchange rate overvaluation'.

Extracts from this document...

Introduction

'Less than credible stabilisation will not eliminate inertia and will generate real exchange rate overvaluation' Inflationary pressures persistently dog every type of economy across the world. However, the pressures are typically much higher amongst many developing counties. In many cases, aside from the lack of necessary economic tools required to combat inflation, a major component in the constraints faced by these countries is the issue of credibility. In this essay I will focus on the role that credibility plays within various stabilisation programs, and more specifically the effect that it has on inflationary inertia and on the real exchange rate. This will be done by looking at the different types of stabilisation programs that have been used, the causes of a lack of credibility of these programs, the steps that governments can take to increase the credibility of its schemes, and finally a conclusion will be drawn regarding the links between credibility and both inflationary inertia and exchange rate overvaluation. Firstly though, it is worth looking at the scope of the effects that inflation has across the world. While the western hemisphere is in no way immune to the threat of inflation, it is true that high levels of inflation are much more widespread amongst developing countries where, as Agenor and Montiel (1996) ...read more.

Middle

Once expectations are formed as a result of a policy announcement, there is a strong temptation on the governments to renege on the policy in order to peruse additional objectives. An example of this would be the incentive to devalue a currency in order to promote output after announcing a fixed exchange rate, the policy that the public's initial expectations were formed around. Governments often have to balance economically sound policies with politically popular ones. Unemployment levels are extremely politically sensitive, with a large rise in unemployment almost certain to cause civil unrest. As decreasing unemployment and disinflation are, by and large, the incentive in this case to renege is high - something that the public and private investors are only too aware. The sequencing of micro and macroeconomic policies is also very important, and the implementation of necessary microeconomic policies such as wage and price controls, or tax reforms, before the macroeconomic measures is essential. If the government fails to do this (as in Argentina in 1985 where wage-price controls were implemented after the announcement of a fixed exchange rate), the stabilisation process will lack credibility and inflationary inertia will still be persistent. Imperfect information: If, as in many developing countries over the years, there is a rapid change of policy makers it is very hard for the public to gauge how credible a government's commitment to disinflation is. ...read more.

Conclusion

To conclude, we have seen that many stabilisation programs, and in particular, those which entail a fixed-exchange rate as a nominal anchor often lack a high degree of credibility. In the case of, amongst others, Chile (1978), Uruguay (1978) and the continuing attempts in Brazil and Argentina these have resulted in an overvaluation of the domestic exchange rate and eventual devaluation. We have also seen that the degree of inflationary inertia faced by an economy will prolong the recovery period from high or chronic inflation. Due to the aforementioned causes of credibility, it makes intuitive sense that such inflationary episodes involving a high level of inertia such as Chile (1965-70, 1972-80 & 1982-86), Bolivia (1973-74, 1982-86) and Zaire (1976-89) as well as the above examples and many others suffered a high level of inertia as a result of the lack of credibility of the stabilisation programs. Edwards, in his study of Chile and Mexico reinforces this view and finds a direct link between the level of inertia and perceived credibility. While it is accepted that the level of credibility that a program holds is by no means the sole factor of inertia or exchange rate overvaluation, it does have a significant influence on them and should be treated with the appropriate regard by any government implementing a stabilisation program. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Budget 2004-05 and Economic Analysis of Pakistan

    The unemployment has increased from 7.82 percent in 2000 to 8.27 percent in 2004. ENERGY: In Pakistan, primary commercial energy supplies increased by 4.0 percent during 2002-03 compared to 1.8 percent in the pervious year reaching 47.1 million tonnes of oil equivalent mainly due to an increase in natural gas,

  2. Governments set economic objectives - Discuss the relative importance of each of these objectives ...

    If inflation is caused by demand pull reasons, then reducing aggregate demand will reduce the inflationary pressures on the economy. Figure 12.0 shows that if inflation is caused by aggregate demand from AD1 to AD3, then prices would have risen.

  1. How have the Rates of Inflation in the UK Changed Since the Monetary Policy ...

    This is quite useful information for understanding the question but the next graph puts the information into greater perspective. Graph 6 Graph 6 has shown how inflation has changed as GDP has changed. The pattern that the data suggest is that inflation is higher during times of recession or very

  2. What ended hyperinflation in Germany, Austria and Hungary in the 1920s? Do the facts ...

    Increased unemployment in the construction industry can be largely attributed to high real interest rates initiated by the newly established central banks as part of the monetary reform. However, the rise in unemployment in Hungary was associated with sharp reductions in the scale of bank operations resulting from the ending of hyperinflation, 4000 employees of financial institutions were discharged.

  1. Comparing the effects of immigration on GDP in Malaysia, Japan and South Africa.

    Government should arrange a stronger and more detailed custom check to ensure that people is unable to sneak in Malaysia illegally. This action allows immigration department to be able to record a more accurate data. Besides, government is able to control the action of foreign workers and to bring peace to their citizens.

  2. Outline any two main/priority issue that concern the Australian economy & discuss the effectiveness ...

    On some occasions policy settings have been changed primary with the objective of restraining the growth of the current account and foreign liabilities. The tightening of both fiscal and monetary policy in the late 1980s was implemented with the aim of reducing consumption and investment; reducing the CAD and also

  1. Pakistan is in the grip of a serious energy crisis that is affecting all ...

    continues living in darkness even in this modernized era.The electricity and power shortage is a chronic problem that has slowed Pakistan's social and economic growth rate EFFECTS ON GROSS DOMESTIC PRODUCT(GDP) AND GNP: Effects on small and large scale business: The continuing power crisis has not only disrupted the daily

  2. Various Macro-Economic Questions and answers

    What is ?the short run? when discussing aggregate supply? What does a short run aggregate supply curve look like? What does a long run aggregate supply curve look like? Why? Explain the factors that will cause a shift in the aggregate supply curve. Shifts in the SRAS curve can be caused by the following factors Changes in unit labour

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work