Two crises: Inflationary inertia and credibility

This paper provides a comparative analysis of the Mexican currency crisis of 1994 and the Chilean crisis of 1982 to assess to what extent exchange-rate-based stabilisation programmes are successful in reducing -or even eliminating -inflationary inertia. The paper provides a brief overview of the Chilean and Mexican reform and stabilisation programmes. A theoretical model that emphasises the role of credibility is developed to analyse the effects of exchange-rate based stabilisation programmes on inflationary inertia. According to the model, less than credible stabilisations will not eliminate inertia and will generate major real exchange rate overvaluation. Detailed data are used to test the hypothesis.