FISCAL DISCIPLINE AND THE CHOICE OF A NOMINAL ANCHOR IN STABILIZATION

The conventional wisdom is that: exchange rate-based stabilizations in duce more fiscal discipline than money-based programs. The Latin Ameri can experience does not support this view, Among the major stabilizati on programs implemented since 1960, the mean increase in the primary b alance-to-GDP ratio was 3.2 percentage points under money-based progra ms, as opposed to only 0.2 percentage points under exchange rate-based programs. We present a model - where fiscal policy is set by an optim izing but non-benevolent government - that replicates this stylized fa ct. If the policy maker is impatient, a money-based stabilization prov ides more discipline, and higher welfare for the representative agent, than does an exchange rate-based stabilization. (C) 1998 Elsevier Sci ence BN, All rights reserved.