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• W1503193140 abstract "Abstract: This paper uses a rational expectations macroeconomic model in which economic agents formulate the probability about the sustainability of the economic policy--that is, policy credibility--using current and lagged values of government expenditures and lagged values of the inflation rate. The estimation of the model is based on Hamilton's switching regime procedure. The contribution of this paper is the empirical estimation of the credibility of the stabilization program implemented in Peru in August 1990. The results of the estimation show that there are two different regimes in the government expenditure process. According to the economic agents' inferences, the stabilization program in Peru is not credible. This lack of credibility in the economic policy of the government authority explains the presence of hysteresis in currency substitution between August 1990 and June 1995. The estimation involves an expected inflation rate that includes the credibility of the economic policy in its formulation. JEL classification: E52, E63, O54 Key words: credibility, stabilization policies, currency substitution, Markov switching model 1. Introduction A policy is credible when economic agents expect policymakers to be successful in implementing their announced economic program. Economic policies are more effective when they are credible to economic agents. In the context of stabilization policies, credibility will help to bring inflationary expectations down and to achieve the goal of disinflation. On the other hand, the lack of policy credibility brings an additional restriction to the economic programs implemented by policy authorities. If economic agents believe that the stabilization program will fail, and the inflation rate will not be reduced, they will allocate some of their monetary assets in foreign currency to offset the loss in their purchasing power. This behavior restricts the base of the inflation tax and imposes more uncertainty on the control of money supply. The lack of policy credibility involves a learning process where the economic agents have observed a prior lack of commitment by the policy authority in continuing the announced policy. The level of credibility is related to the time-inconsistency problem in the implementation of economic policies. The policy authority will not fully commit to its economic program because, after its announcement, there will be short run incentives to repudiate the original plan. These incentives come from a lack of control of the policy instruments, inconsistency between economic policies, political and administrative constraints and uncertainty about the predictability of policy reforms due to exogenous shocks. During the 1980s, several Latin American countries experienced failed stabilization programs. On several occasions, the failure of stabilization programs was due to the lack of commitment to reduce the fiscal deficit. This was due to the lack of control of policy instruments such as in the Austral Plan in Argentina, the Cruzado Plan in Brazil or the Inti Plan in Peru. On other occasions, the previous failure of these programs has contributed to the lack of credibility in economic policy even though the governments have shown greater commitment and consistency in their economic programs in the recent years. In this study, I examine the credibility of stabilization policies and its effect on the hysteresis present in the process of currency substitution. Due to the lack of credibility in stabilization policies, economic agents may have maintained high expectations of both inflation and depreciation of the domestic currency. Even if inflation rates decrease and exchange rates become more stable, the lack of policy credibility may cause economic agents to continue holding their assets in foreign currency. They will continue to keep their deposits in foreign currency because they expect that the policy authority will abandon their policy. …" @default.
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• W1503193140 date "2003-01-01" @default.
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• W1503193140 title "Stabilization Programs and Policy Credibility: Peru in the 1990s" @default.
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• W1503193140 doi "https://doi.org/10.2139/ssrn.488722" @default.
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