SUPPLY-SIDE EFFECTS OF DISINFLATION PROGRAMS

This paper focuses on the short- and long-run supply-side effects of d isinflation programs in a two-sector economy. Fixing the exchange rate reduces the wedge between the return on foreign assets and that on do mestic capital, leading to an increase in the latter. After an initial real exchange rate appreciation and increase in the production of non tradables-resulting from a consumption boom-the new capital is gradual ly installed in the tradable sector. During this transitional period, further real appreciation takes place-as the expansion of the tradable sector pulls labor away from the nontradable sector-together with inv estment-driven deficits in the current account. We conclude that when appreciation and deficits are due to supply-side rigidities, rather th an to credibility and/or price stickiness, no further policies (e.g., capital controls, incomes policies) are advisable.