WHY IS INFLATION SO LOW AFTER LARGE DEVALUATIONS?

MŰHELYTANULMÁNYOK DISCUSSION PAPERS

ÚJ SOROZAT NEW SERIES

MT–DP. 2003/8

WHY IS INFLATION SO LOW AFTER LARGE DEVALUATIONS?

ARIEL BURSTEIN,

MARTIN EICHENBAUM

SERGIO REBELO

Institute of Economics Hungarian Academy of Sciences

Budapest

MŰHELYTANULMÁNYOK DISCUSSION PAPERS

NEW SERIES 2003/8

WHY IS INFLATION SO LOW AFTER LARGE DEVALUATIONS?

ARIEL BURSTEIN,

MARTIN EICHENBAUM

SERGIO REBELO

Budapest June 2003

KTK/IE Discussion Papers 2003/8

Institute of Economics Hungarian Academy of Sciences

KTK/IE Discussion Papers are circulated to promote discussion and provoque comments. Any references to discussion papers should clearly state that the paper is preliminary. Materials published in this series may subject to further publication.

Why is Inflation so Low after Large Devaluations?

Authors: Ariel BURSTEIN, University of Michigan

Martin EICHENBAUM, Northwestern University, NBER and Federal Reseve Chicago

Sergio REBELO, Northwestern University, NBER and CEPR

We thank Jorge Roldos for his comments and Robert Gordon for useful

discussions. We also thank Ilan Goldfajn for his suggestions and for providing us with additional data for Brazil. We gratefully acknowledge financial support from the National Science Foundation.

Published by the Institute of Economics Hungarian Academy of Sciences, Budapest, 2003.

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Abstract

This paper studies the behavior of inflationnafter nine large post-1990 contractionary devaluations. A salient feature of the data is that inflation is low relative to the rate of devaluation. We argue that distribution costs and substitution away from imports to lower quality local goods can account quantitatively for the post-devaluation behavior of prices.

Keywords: inflation, devaluation, exchange rates JEL Classification: F31

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Összefoglaló

A tanulmány az 1990 után történt kilenc nagyobb recesszióval együttjáró

leértékelést követő inflációs viselkedést vizsgálja. Az adatok egyik szem-

beötlő jellemzője az, hogy a leértékelések mértékéhez viszonyítva túlságo-

san alacsony az infláció. A tanulmány megmutatja, hogy egyrészt a for-

galmazási költségek szerepe, másrészt az alacsonyabb minőségű helyi ter-

mékek iránt eltolódott kereslet magyarázhatja meg az árak leértékelés utá-

ni viselkedését.

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