Exchange‐Rate‐based Stabilisation, Durables Consumption and the Stylised Facts

Abstract

In this article we show that a model featuring durable consumer goods, imperfect substitution between domestic and foreign assets, and weak credibility can explain the qualitative and quantitative aspects of the stylised facts associated with exchange-rate-based stabilisation, including the tremendous increase in real interest rates. Following a temporary reduction in the crawl, total consumption spending rises 14–26%, the real exchange rate appreciates 20–37% and the current account deficit swells to 10–15% of gross domestic product. Despite large capital inflows, the real interest rate increases from 10 to 20–100%.