Stabilization Policies
Heterodox/Orthodox Paradox

Argentina, Bolivia, Brazil and Israel have each experienced very high rates of inflation in recent years. Each had tried to reduce inflation, and had failed. As a result, in 1985/6 they all abandoned the earlier policies of 'gradualism' in favour of various forms of 'shock treatment'. In Argentina, Brazil and Israel the new anti-inflation programmes involved a mixture of orthodox measures, such as once-off devaluations, with less orthodox policies, such as wage and price controls. The strategy adopted in Bolivia was more conventional, allowing prices and the exchange rate to fluctuate with market forces. Despite early successes, however, it is not yet clear whether any of these shock treatments have really worked, Research Fellow Sweder van Wijnbergen told a lunchtime meeting on 1 December. These 'crash' programmes had produced dramatic falls in the rate of inflation almost immediately. In Bolivia, for example, inflation fell very rapidly from a peak annual rate of 26,000% to 14%. But we do not know whether these reductions can be sustained; inflation has since risen again in both Argentina and Brazil. Appropriate fiscal policies are important for the credibility of the whole package, according to van Wijnbergen. Since the extent and permanence of fiscal measures is not yet clear, however, it remains an open question whether the success of the wage and price controls could be sustained, he concluded.

Sweder van Wijnbergen is a Senior Economist at the World Bank and a Research Fellow in the Centre's International Macroeconomics and International Trade programmes. His research has included the analysis of fiscal, monetary and trade policies and the effects of oil price shocks. He is the author of an article in Issue No. 1 of Economic Policy, on North-South macroeconomic interdependence, and is co-editor with J Peter Neary of the CEPR volume Natural Resources and the Macroeconomy. The lunchtime meeting at which he spoke was sponsored by the German Marshall Fund of the United States. The opinions expressed by Dr van Wijnbergen were his own, however, and not those of the World Bank, the German Marshall Fund or of CEPR, which takes no institutional policy positions.

Wage and price controls are the most controversial aspect of the three 'heterodox' programmes, van Wijnbergen noted. Before freezing prices, both Argentina and Israel made major adjustments in public sector prices and subsidies, and announced that they would gradually release the price controls. In Brazil, the price freeze was announced for an indefinite period. The use of price controls distinguishes these packages from other attempts to end hyperinflation, such as those in Germany in the 1920s and Bolivia in 1985.

The heterodox countries adopted very different wages policies, however. In Brazil, nominal wage adjustments before the imposition of the freeze actually raised real wages, and attempts to lower real wages in Argentina were unsuccessful. But the Israeli experience was quite different, and very unusual (see the article by CEPR Research Fellow Michael Bruno in Issue No. 2 of Economic Policy). After the stabilization plan was announced, a temporary real wage cut was negotiated with the powerful Histadrut labour movement, designed to avoid 'distress' lay-offs by enterprises with temporary liquidity problems. This had important macroeconomic effects: real wages fell by 18% over the second half of 1985, but by March 1986 they had, as intended, recovered all but 3% of their average value in the first half of 1985.

The heterodox countries chose to adopt a fixed exchange rate against the dollar, whereas previously they had adjusted their exchange rate in line with the difference between foreign and domestic inflation rates. The subsequent slide of the dollar against other major currencies and the fall in the price of oil provided the heterodox countries with the windfall of improved competitiveness. In Argentina this helped to offset a disappointing inflation performance immediately after the plan's introduction. Recently, both Argentina and Brazil have had to abandon fixed exchange rates in favour of policies which maintain export competitiveness.

Monetary policy and the behaviour of interest rates varied significantly among the four countries. Neither Brazil nor Israel committed itself to a strict money growth rule, and real rates of interest did not increase significantly from their already high levels. The Argentinian government, however, gave an undertaking not to finance the public sector by printing money. Accordingly, the short-term behaviour of real interest rates, investment, and output was very different in Argentina: real interest rates rose significantly, and the output costs of the anti-inflation programme seem to have been higher, although relatively short- lived. Van Wijnbergen's personal view was that such money supply restrictions might be unnecessary or counter-productive in anti- inflation programmes, because when inflation falls dramatically it is natural that the real demand for money balances should increase.
All four countries achieved dramatic reductions in inflation during the initial months of the stabilization policies. But the output costs of the programmes varied widely. In spite of high real interest rates and tighter fiscal policy, there were no significant falls in output and no major increases in unemployment in the heterodox countries, which had adopted wage and price controls. In Israel, output even seems to have accelerated shortly after the introduction of these programmes. In Brazil, the plan was introduced in the midst of an expansion, and growth continued at the same pace after the policy's introduction. Argentina experienced the depth of the recession in the quarter following the programme, but a recovery quickly followed. In Bolivia, however, a more orthodox stabilization programme was followed by a deep recession. But the far better output and employment records of the three heterdox countries might be the result of the artificial suppression of very high inflation, van Wijnbergen noted. The consumer booms in these countries may be the result of decisions to buy now while prices are low.
In the discussion after the talk, one member of the audience argued that wage and price controls inflicted a great deal of long-run damage to the economy, by distorting real prices and incentives. But these controls were not permanent, van Wijnbergen observed; Argentina and Israel had both announced that they would gradually be relaxed and eventually removed. Even the dramatic fall in bank profits in Brazil could not be attributed to wage and price controls. During the high inflation there had been an increase in demand for banking services, and many more branches had been established; the fall in the demand for banking services was the result of successful disinflation.

It was also argued that the IMF put too much emphasis on monetary policy; the anti-inflation programmes outlined in the talk had not been the result of pressure from the IMF, initiatives which should encourage and reward such successful packages. Van Wijnbergen agreed: his personal belief was that the IMF overemphasized monetary policy; adjustment programmes should not add to the domestic difficulties of governments attempting to tackle hyperinflations. There was a case for increased external lending to such governments he suggested, since the cutting off of credit from the rest of the world requires that exports be used to pay off the external debt and can trigger more inflation.

The relationship between consumer spending and the trade balance was also discussed. In Brazil, increased real wages and higher employment had contributed to the consumer boom and a trade deficit. Consumers were deciding to buy now, perhaps expecting that prices would accelerate again. This might indicate that the anti-inflation programme was not sustainable.