Exchange-Rate-Based Stabilization, Durables Consumption, and the Stylized Facts

Abstract

In this paper 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 stylized facts associated with exchange-rate-based stabilization, 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 GDP. Despite large capital inflows, the real interest rate increases from 10% to 20-100%.