Abstract
The article focuses on the design of stabilization measures to correct excessive balance of payments deficits and moderate the rate of inflation. It distinguishes three sources of balance of payments difficulties—excessively expansionary aggregate demand policies; domestic supply shocks stemming, for example, from increases in real wages in excess of productivity growth; and external terms of trade shocks. It also analyzes the effects of devaluations. The second part of the article discusses policies aimed at reducing the rate of inflation and summarizes the theoretical literature on the dynamics and the transitional costs of adjustment to lower rates of inflation in closed economies. Evidence on the adjustment costs of disinflationary policies is reviewed, and the discussion is extended to some recent analysis of adjustment in open economies.
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