Stabilization with Exchange Rate Management.

Stabilization programs in open economies typically consist of two stages. In the first stage, the rate of currency devaluation is reduced, but the fiscal adjustment do es not eliminate the fiscal deficit that causes growth of debt and lo ss of reserves, making a future policy change necessary. Only later, at a second stage, is this followed by either an abandonment of excha nge-rate management or by a sufficiently large cut in the fiscal defi cit. The authors study how different second-stage policy changes affe ct economic dynamics during the first stage. These changes include ta x increases, budget cuts on traded and nontraded goods, and increases in the growth rate of money. Copyright 1987, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.