Inflation stabilization and external shocks: A case study of Bolivia

Many inflation stabilization programmers are based on exchange rate stabilization. Under most circumstances the stock of net foreign reserves (NFR) plays a crucial role in the credibility and success of exchange rate stabilization, as has been stressed by Dornbusch (1991). A rapid depletion of NFR caused by an exogenous shock may severely imperil a programmed otherwise well designed. In the mid 1980s, many Latin American countries, that were in the midst of a stabilization effort, suffered abrupt and strong losses in their terms-of-trade (TOT) and their export incomes. The cumulated losses over the selected years in the table are impressive. Only Brazil could sustain its exports, despite the TOT loss.