Intersectoral Conflict, Exchange Rate Uncertainty, and Delays in Macroeconomic Stabilization

Abstract

An important body of literature explores the political economy reasons underlying delays in macroeconomic stabilization. This paper develops a framework to analyze the conflict between two risk-averse groups of economic actors, one that has an endowment of internationally tradable goods and another that is endowed with nontradable goods: both endowments require imported inputs to consume. The focus is on the exchange rate policy in a developing country setup, where the government employs seigniorage revenue to finance prestabilization spending, and faces fiscal and balance of payments problems that necessitate stabilization with a step devaluation. Trade misinvoicing, the presence of exchange rate uncertainty and its interaction with import costs, the role of forward-looking expectations, and the possibility of foreign/IMF aid influence the likelihood, timing, and terms of a consensus on stabilization in interesting ways. Crucially, given instrument uncertainty, delays may occur even if both sets of agents have perfect foresight and nontradable endowment-holders realize that their relative position deteriorates over time.