Central Bank Independence in Transition Economies


Balance of Payment Motive for Devaluation



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1.1.3. Balance of Payment Motive for Devaluation 

Another motive for inflationary policy is a concern about the balance of payment 

deficit. The relation between nominal devaluation and the balance of payment position 

is given in Cukierman (1992). The nominal devaluation may reduce real wages and, in 

the presence of nominal contracts, increases employment and output. Hence, more 

resources are available for export or for import substitution and the current account 

position improves. The higher output increases domestic consumption and import but, 

if the marginal propensity to consume is smaller than one, export grows more than 

import. However, the gains from the expansion are the short-term only. While the 

contracts are renegotiated, the economy returns to the equilibrium employment and 

output. In the rational expectations framework people know that the policymakers are 

tempted to reduce their wages. Consequently, private agents set higher nominal wages 





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