Disinflation and the Supply Side
The authors study the dynamics of output, consumption, and real wages induced by a disinflation program based on permanent and temporary reductions in the nominal devaluation rate. They use an intertemporal optimizing model of a small open economy in which domestic households face imperfect world capital markets, the labor supply is endogenous, and wages are flexible. The model predicts that, with a constant capital stock and no investment, there is an initial reduction in real wages and output expands. Consumption falls on impact but increases afterward. In addition, with a temporary shock, a current account deficit emerges and, later a recession sets in, as documented in various studies. With endogenous capital accumulation, numerical simulations show that the model can also predict a boom in investment.
Summary: | The authors study the dynamics of
output, consumption, and real wages induced by a
disinflation program based on permanent and temporary
reductions in the nominal devaluation rate. They use an
intertemporal optimizing model of a small open economy in
which domestic households face imperfect world capital
markets, the labor supply is endogenous, and wages are
flexible. The model predicts that, with a constant capital
stock and no investment, there is an initial reduction in
real wages and output expands. Consumption falls on impact
but increases afterward. In addition, with a temporary
shock, a current account deficit emerges and, later a
recession sets in, as documented in various studies. With
endogenous capital accumulation, numerical simulations show
that the model can also predict a boom in investment. |
---|