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This paper has been prepared for the Interamerican Seminar on Economics. We are grateful to Mohsin Khan for his comments on an earlier draft.
According to the IMF (1988), as of June 30, 1988, a total of 90 developing countries maintained an official parity for their currencies.
The absence of consensus can be documented, for example, in the “contractionary devaluation” debate (see the recent survey by Lizondo and Montiel (1989)).
The endogeneity of the rate of time preference is introduced to ensure the existence of a steady-state solution in the presence of perfect capital mobility. As Obstfeld (1981) points out, unless either the rate of time preference or the market interest rate is endogenous, the economy will not converge to a steady state.
The application of the maximum principle is greatly simplified by expressing the problem in terms of Δ, rather than t.
Notice that (6) is satisfied for paths that begin on SS, since for such paths at converges to a constant steady-state value a*.
By having the government turn over any bonds it accumulates to the central bank in exchange for claims on the bank, bG can also be regarded as part of the bank’s stock of foreign exchange reserves.
The case of reduced spending on traded goods (gT) is uninteresting, since this policy has no effect on the private sector. Spending on traded goods is reduced until the desired accumulation
λ can be interpreted as the marginal contribution to the household’s well-being of an extra unit of wealth. A path in which λ increased (say) discontinuously at time t+s could not be optimal, since it would be dominated by a otherwise identical path in which the household saved marginally more just prior to t+s.
The proof of this proceeds as follows: the solution of the consumers’ problem in (a,λ) space shows that λ rises when τ is increased. The longer the increase in τ lasts, the larger the initial jump in λ. By (33), this requires a smaller initial Ƶ. If the jump in λ is sufficiently large, the initial change in Ƶ must be negative.
The coincidence of a tax cut and spending decrease may seem paradoxical. Recall, however, that this is an anticipated tax cut, the enactment of which does not increase the household’s anticipated resources over its planning horizon.
In either of these cases, private consumption is always below the steady-state value that would prevail in the absence of government asset accumulation.