This paper uses a rational expectations macroeconomic model in which economic agents formulate the probability about the sustainability of the economic policy—that is, policy credibility—using current and lagged values of government expenditures and lagged values of the inflation rate. The estimation of the model is based on Hamilton’s switching regime procedure. The contribution of this paper is the empirical estimation of the credibility of the stabilization program implemented in Peru in August 1990. The results of the estimation show that there are two different regimes in the government expenditure process. According to the economic agents’ inferences, the stabilization program in Peru is not credible. This lack of credibility in the economic policy of the government authority explains the presence of hysteresis in currency substitution between August 1990 and June 1995. The estimation involves an expected inflation rate that includes the credibility of the economic policy in its formulation.
JEL classification: E52, E63, O54
Key words: credibility, stabilization policies, currency substitution, Markov switching model
The author thanks Stanley Black and Francisco Ruge-Murcia for helpful comments and suggestions. She also benefited from comments received during presentations at the Federal Reserve Bank of Atlanta, LACEA, and Latin American Econometric Meetings. The views expressed here are the author’s and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the author’s responsibility.
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