CURRENCY DEVALUATION AND CONTRACTIONARY POLICY IN CURRENCY CRISIS: A SUPPLY-SIDE APPROACH

In a series of recent currency crises involving Asian and Latin American countries, the IMF mandated its standard contractionary programs to the countries it had bailed out. Focusing on the supply side of an economy, we argue that the deflationary programs may have adverse effects for countries, which relies heavily upon imported intermediate goods and raw materials. A devaluation will raise the domestic price of these imported factors, triggering cost-induced seller's inflation and reducing production. This process will increase unemployment, accelerate inflation, and leave the currency account in deficit. In the end the economy is likely to sustain a more painful correction than is justified.