Journal Issue

Policy choices to stabilize inflation: Is there space for political opportunism?

International Monetary Fund. External Relations Dept.
Published Date:
August 2004
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In the late twentieth century, many developing countries, especially in Latin America, experienced chronically high inflation. Policymakers responded with one of two possible strategies: exchange-rate-based stabilization, which involves pegging the country’s currency to that of a low-inflation country, or a money-based approach, which involves aiming for intermediate targets for monetary growth. In a new IMF Working Paper, Ari Aisen, of the IMF’s Western Hemisphere Department, examines the extent to which the policy choice is determined by political, rather than economic, motives.

Exchange-rate based and money-based stabilization strategies can have similar effects on an economy’s welfare, but they tend to lead to different consumption cycles, and Aisen suggests that policymakers may be taking advantage of these differences to further their political careers. The most striking difference between the two approaches is in their effects on consumption and economic activity. Exchange-rate-based stabilization programs generate an initial consumption boom and, later, a recession in the economy, whereas money-based stabilizations generate an early consumption bust followed by a recovery.

Knowledge of these consumption patterns, Aisen believes, allows opportunistic politicians—who take into account the timing of elections when choosing a particular policy—to use the two anchors to their benefit. They are more likely to use exchange-rate-based stabilization prior to elections and a monetary anchor after elections. Aisen cautions, however, that while initial consumption booms make exchange-rate-based stabilizations more attractive than money-based approaches, “the former often lead to balance of payments crises, loss of international reserves, and major devaluations. Therefore, it is not always a simple task to decide which stabilization strategy to pursue. This might be especially true if the economy is in a recession prior to the launching of the stabilization program.”

Timing of stabilization programs provides evidence of political opportunism

Stabilization program1BeginningTypeElectionsElections
Argentina (Austral I)Jun-85ERBSOct-83Oct-85
Argentina (Austral II)Oct-87ERBSOct-85Oct-87
Argentina (BONEX)Dec-89MBSMay-89Oct-91
Argentina (Convertibility plan)Apr-91ERBSMay-89Oct-91
Brazil (Cruzado plan)Feb-86ERBSNov-82Nov-86
Brazil (Collor plan)Mar-90MBSNov-89Oct-94
Brazil (Real plan)Jul-94ERBSNov-89Oct-94
Dominican RepublicAug-90MBSMay-90May-94
Note: ERBS= exchange-rate-based stabilization; MBS = money-based stabilization.

This table includes only a small sample of the stabilization programs examined in Ari Aisen’s study.

Data: IMF Working Paper No. 04/94
Note: ERBS= exchange-rate-based stabilization; MBS = money-based stabilization.

This table includes only a small sample of the stabilization programs examined in Ari Aisen’s study.

Data: IMF Working Paper No. 04/94

Does the policy choice really matter?

Do the different consumption and activity cycles associated with the two stabilization strategies compel policymakers to choose exchange-rate-based stabilization before elections and money-based stabilization after elections? Some researchers have suggested that the only difference between them is when the stabilization costs will be paid—earlier in the case of a money-based stabilization and later in the case of an exchange-rate-based stabilization.

Other studies dispute whether distinctive empirical regularities do, indeed, follow exchange-rate-based and money-based stabilization. One study, for example, concludes that the consumption and output cycles that appear to have followed exchange-rate-based stabilization have occurred because exchange-rate-based stabilizations have generally been launched when the world economy has been booming and the country has experienced positive terms-of-trade shocks. Consumption booms after exchange-rate-based stabilization have therefore been more the result of positive macroeconomic shocks than of the choice of nominal anchor. Others argue that boom and bust cycles are determined by an economy’s initial conditions, such as the level of GDP and international reserves, and bear no relation to the choice of anchor for stabilizing inflation.

What Latin America did

Nevertheless, says Aisen, empirical evidence suggests that the political dimension plays an important role in the choice of stabilization strategy. In several Latin American countries, for example, policymakers chose exchange-rate-based stabilization before an election. In Brazil, for instance, voting intentions in the 1994 presidential campaign changed in favor of the candidate who launched the Real Plan (an exchange-rate-based stabilization) in July of the same year. The December 1987 Mexican exchange-rate-based stabilization is another case where the plan came before elections occurred. A few months later, in July 1988, Carlos Salinas was elected as president of Mexico, and voters—enthusiastic about the ongoing consumption boom—praised his party’s chosen strategy to stabilize the economy. Other exchange-rate-based strategies—such as Argentina’s 1985 Austral and 1991 Convertibility plans, and Brazil’s 1986 Cruzado plan—seem to have been related more to congressional elections.

Money-based stabilization, in contrast, seems to have occurred after elections. The BONEX plan in Argentina, for example, was launched in 1989 by the newly elected government headed by Carlos Menem. The Collor plan in Brazil was launched in March 1990, right after Fernando Collor de Melo was elected president. Other money-based programs, such as those introduced in Peru in 1990 and the Dominican Republic in 1990, also came after elections. Aisen points out that “the consumption busts that follow money-based stabilization represent a great political cost to be avoided before important elections; rather, the incumbent would prefer the cost to be paid as soon as the new government is in charge so that the economic recovery can take place later in the same presidential term. Furthermore, money-based stabilization launched soon after elections may serve the purpose of blaming the past administration for the harsh recession that inevitably follows.”

The choice of stabilization strategy, adds Aisen, might also be related to the level of support enjoyed by the politicians. Money-based programs were usually launched right after the newly elected governments took power and had a very high stock of political capital. This allowed the government to adopt a short-run strict strategy to stabilize inflation, even at a cost of a deep recession. Conversely, exchange-rate-based stabilizations could be thought of as an instrument to increase political capital prior to elections.

Looking at the relationship between GDP growth and the timing of the stabilization attempts and elections in Argentina and Brazil, Aisen finds that Argentina’s 1985 Austral plan and Brazil’s 1986 Cruzado plan succeeded in promoting growth at least up to when the elections occurred in October 1985 in Argentina and in November 1986 in Brazil. Evidence also shows that two typical money-based stabilization programs—Argentina’s 1989 BONEX plan and Brazil’s 1990 Collor plan—that were launched soon after elections generated strong recessions. They were evidence, again, notes Aisen, that the type of stabilization program may have been opportunistically selected.

Evidence of political opportunism

With the help of an econometric model, Aisen looks more formally for evidence of political opportunism in the choice of a stabilization policy. Using data on 34 full-fledged stabilization episodes—mostly in Latin America, but also in Israel and Turkey—he finds that the timing of elections affects the choice of anchor for stabilization. In particular, policymakers assess how distant the next elections are before making their choice of nominal anchor in the inflation stabilization program that they have decided to embark on. The probability that policymakers adopt an exchange-rate-based stabilization is higher when they are closer to the date set for future elections. The probability of adopting a money-based stabilization, on the other hand, is higher when elections have been recently held.

Moreover, Aisen’s results show that a relatively large stock of international reserves, a high degree of openness, and high political fragmentation not only increase the probability of adoption of an exchange-rate-based stabilization but also affect the degree of political opportunism behind the choice of nominal anchor for stabilization. For example, different policymakers who decide to launch a stabilization program at different stages of the election cycle will have, respectively, a 45 percent probability of choosing the exchange rate as the anchor three years before elections, 78 percent two years before elections, and 99 percent one year prior to elections, for the case where reserves cover 10 percent of a country’s broad money supply.

Improving the quality of economic policy

Aisen’s study aims to contribute to the understanding of the interaction between political and economic forces. He suggests that a similar methodology could be used to study the extent to which political opportunism plays a role in a whole range of economic policy choices. An interesting assessment would also be whether the impact of electoral politics on economic policy varies between developed and developing countries. If so, Aisen suggests, “strengthening the institutions that oversee politicians in developing countries might reduce the degree of political opportunism, which, in turn, may improve the quality of economic policy in these countries.” In Aisen’s view, the study also has important implications for the IMF’s work. “We must be aware of the political incentives behind economic policies,” he says, “so as to avoid supporting a particular political agenda instead of the best economic agenda”

Copies of IMF Working Paper No. 04/94, “Money-Based Versus Exchange-Rate-Based Stabilization: Is There Space for Political Opportunism?” by Ari Aisen, are available for $15.00 each from IMF Publication Services. See page 254 for ordering information. The full text of the paper is also available on the IMF’s website (

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