Working Paper: NBER ID: w1739
Authors: Rudiger Dornbusch
Abstract: The essay is an extended version of the Frank D. Graham Lecture presented at Princeton University in May 1985. It discusses the interaction of inflation and exchange rate policy in a variety of contexts. Four different settings are used to highlight that role: the experiments with exchange rate overvaluation in the Southern Cone; the place of exchange depreciation in the transition from high to even higher inflation discussed in the context of Brazil; exchange rate fixing and real appreciation during stabilization in the 1920s; and finally the U.S. real appreciation of 1980-85. The common thread of the argument is that exchange rate policy can make an important contribution to stabilization, but that it can also be lead to persistent deviations from PPP, with devastatingly adverse effects.The essay investigates through what channels these PPP deviatiins arise and how they influence inflation, trade and capital flight.
Keywords: Inflation; Exchange Rates; Stabilization
JEL Codes: E31; E52; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed exchange rate policy aimed at controlling inflation (E64) | significant overvaluation (D46) |
| significant overvaluation (D46) | capital flight (F21) |
| significant overvaluation (D46) | increased imports (F10) |
| fixed exchange rates can initially stabilize inflation (F31) | adverse outcomes such as capital flight when the overvaluation becomes unsustainable (F32) |
| tablita policy of pre-set declining exchange rate depreciation (F31) | rapid escalation of inflation when the system broke down (E31) |
| U.S. dollar appreciation during the 1980-85 period (F31) | reducing inflation (E31) |
| U.S. dollar appreciation (F31) | lowering import prices (F14) |
| U.S. dollar appreciation (F31) | lowering commodity prices (Q02) |