ON GRADUAL DISINFLATION, THE REAL EXCHANGE-RATE, AND THE CURRENT ACCOUNT

We study the effects of a credible, gradual exchange-rate-based disinf lation program in a two sector economy. After an initial exchange rate depreciation, the reductions in the rate of devaluation reduce the mo netary wedge generated by the cash-in-advance constraint, leading to a gradual increase in absorption that yields progressive real exchange rate appreciations and current account deficits. An initial boom in ec onomic activity is not followed by a later contraction, as labour supp ly expands during the whole length of the program. Many of the model's predictions are in accordance with the stylized facts on disinflation in chronic-inflation countries, in particular those of the Mexican pr ogram of 1988-1992. (C) 1997 Elsevier Science Ltd.