Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies

This paper uses calibrated versions of a sticky-price currency-substitution model to compare the initial dynamics and welfare costs of three ty pes of stabilization program: exchange-rate-based (ERB), money-based (MB), and mo ney-based with initial reliquefication (MBR). ERB and MBR programs are foun d to induce an initial expansion in real activity, whereas MB programs are initially contractionary. The welfare gains of eliminating high inflation a re significant under permanent ERB and MBR programs hut small under permane nt MB programs. In addition, temporary MB programs are shown to be much mor e disruptive than temporary ERB or MBR programs. These results provide an e xplanation for why MB programs are so rarely implemented and suggest that e mpirical studies that fail to distinguish MB from MBR programs are likely t o be biased toward finding that stabilizations are always expansionary rega rdless of the nominal anchor. (C) 1999 Elsevier Science B.V. All rights res erved. JEL classification: F41.