Why some countries succeeded while others eventually failed
In the mid-1980s, a number of countries suffering from chronic high inflation—typically in the three-digit range—adopted what are now widely known as the “heterodox” stabilization programs. The main innovation was the inclusion of income policies (that is, temporary wage and price controls). The idea was to bring down inflation quickly at the outset, without incurring high costs, in terms of unemployment and output. In all other respects, the programs were very orthodox, centered on reducing budget deficits and restraining the growth of the money supply.
Of the countries that experimented with the heterodox approach, the best-known ones are Argentina (the 1985 Austral plan), Israel (the 1985 stabilization program), and Mexico (the 1987-88 Solidarity Pact, the Pacto). Brazil’s 1986 Cruzado plan is sometimes put in this category, but it sharply differs from the others in that it bypassed from the outset the much-needed adjustment in the fiscal accounts.
Soon after these programs were implemented, the use of income policies—combined with the orthodox approach—looked to be an extremely promising alternative. Its success rate was high, and the costs, in terms of recession or unemployment, were low. With a few more years behind us, however, the verdict has changed somewhat. For some of these countries, notably Israel and Mexico, inflation has remained relatively low, at around 20 percent per year. But the costs—in terms of high interest rates, slow recovery of growth, and loss in external competitiveness—have been much higher than originally anticipated. Moreover, the removal of controls has proved difficult, there has been a loss in exchange rate flexibility, and the process of consolidating low inflation has been time-consuming (over two years in Mexico and even longer in Israel). For others, such as Argentina (and Brazil), income policies have proved counter-productive, because they were not supported by a sustained fiscal effort. Indeed, after the Austral (and Cruzado) plans failed, hyperinflation returned and with an unprecedented vengeance.
This article is based on a longer paper, “When Do Heterodox Stabilization Programs Work?,” World Bank Research Observer, January 1992.
This article reexamines the record of these programs (see “Some Lessons from ‘Heterodox’ Stabilization Programs,” by Mario I. Blejer and Adrienne Cheasty, Finance & Development, September 1988, for an earlier assessment), taking advantage of the time that has now elapsed. Our conclusion is that income policies of the type used in the heterodox programs should only rarely be applied (i.e., under very specific circumstances), and even then, with a great deal of care.