Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies

This paper uses calibrated versions of a sticky-price currency-substitution model to compare the initial dynamics and welfare costs of three types of stabilization program: Ž . Ž . exchange-rate-based ERB , money-based MB , and money-based with initial reliqueficaŽ . tion MBR . ERB and MBR programs are found to induce an initial expansion in real activity, whereas MB programs are initially contractionary. The welfare gains of eliminating high inflation are significant under permanent ERB and MBR programs but small under permanent MB programs. In addition, temporary MB programs are shown to be much more disruptive than temporary ERB or MBR programs. These results provide an explanation for why MB programs are so rarely implemented and suggest that empirical studies that fail to distinguish MB from MBR programs are likely to be biased toward finding that stabilizations are always expansionary regardless of the nominal anchor. q 1999 Elsevier Science B.V. All rights reserved. JEL classification: F41