PRICE-OUTPUT DYNAMICS, CAPITAL INFLOWS AND REAL APPRECIATION

Abstract

RECENTLY a number of semi-industrialized economies in Latin America attempted to bring down their inflation rates through the novel method of preannouncing a lower rate of crawl of the domestic currency. Implemented as part of a larger stabilization program involving complementary monetary and fiscal measures, the aim of this policy was to abruptly break inflationary expectations and thereby produce a quick, smooth transition to a lower rate of inflation.1 The transition proved to be neither quick nor smooth. In the short-run, there was an unexpected boom in which output increased strongly but the inflation rate fell little or, perversely, increased. The initial boom was then quickly followed by a bust of equal or greater severity. Most puzzling, however, the inflation rate remained far above the rate of crawl in the downturn despite sharp deceleration in growth and large increases in the number of unemployed. This bizarre cycle was seen most clearly in Argentina and Uruguay over the period of 1979-80.2 The preannounced crawl experiment has been the subject of recent papers by Dornbusch (1980), Krugman (1980), Calvo (1982), and Rodriguez (1982). These papers have advanced various explanations for the initial phase in which the inflation rate remains high and there is steady real