Inflation stabilization with incomes policy support.

Introduction

In 1985-6 Argentina, Brazil and Israel initiated programmers of stabilization after episodes of high and sharply accelerating inflation. Among the key features of each stabilization programme were the use of wage-price controls, a fixed exchange rate and fiscal correction as well as a significant expansion in the nominal quantity of money. The combination of fiscal correction and incomes policy has come to be known as 'heterodox' stabilization policy, thus opposing it to the conventional IMF programmes which emphasize tight monetary and fiscal policies as the exclusive instrument of stabilization.

The stabilization programmes in Argentina and Israel have now been in force for over a year and the more recent one in Brazil for half a year.(**) There is accordingly enough evidence to make a first judgement on the successes and the limitations of these new schemes. At the same time it is worthwhile spelling out some of the special features of stabilization and the resulting intellectual case for heterodox programmes. We leave little doubt that the concept of these new programmes is entirely correct--a longstanding disdain for controls by the economics profession notwithstanding. However, we also emphasize that the temptation to forget about fundamentals is extraordinarily great and ultimately fatal to stabilization.

A main point of this chapter is to isolate the precise role these programmes can expect to play. Our point is that they provide an immensely valuable breathing-space in which price stability can be established without deep recession. As a result, the very strong political support for the programme and the policy-makers yields a platform from which to make the inevitable adjustments in the budget which are the ultimate pillars of stabilization. We note that mistaking the breathing-space for success, and failure to use the political support at its height for the difficult task of fiscal correction, will mean that the programme must soon slip. And when it does slip it does so irrecoverably. The focus then is on how these programmes, unlike traditional programmes, do provide an immediate, temporary and very favourable opportunity for basic policy reform. Even if they do not provide a magic relief from the necessity of fiscal correction, they surely represent a significant opportunity to try to achieve policy reform. Before, in innumerable cases, that proved impossible or was overly delayed because of the perception of immense political costs associated with high unemployment and slow disinflation.

Table 3.1 gives an idea of the possible and impossible approaches to inflation stabilization. The table highlights two dimensions of policy: whether or not the programme includes fiscal correction or austerity and whether the programme has an incomes policy (wage, price and exchange rate freezing together with remonetization to be explained below). The standard programme in the lower left-hand box is the IMF approach, which consists of fiscal austerity but does not make incomes policy a key instrument. It is true that the IMF favours wage restraint, but price controls are not typically, or ever, an item on the conditionality list. The alternative is shown in the upper left-hand box where the heterodox programmes are located. They combine an incomes policy with fiscal austerity.

The remaining two boxes are essential to an understanding of what the temptations are in the course of stabilization and where they lead. The most common is to attempt stabilization by controls only, without paying attention to the sine qua non of fiscal correction. This box is crowded with many thousand years of failed experiments from Emperor Diocletean to the modern experiments of the Peronists in 1973-4, of Richard Nixon, or of Israel in early 1985. Inevitably these programmes come to an end after a more or less brief period of effectiveness. They fail when shortages become a sufficient political headache. There may be an additional phase in which magicians get a shot, without controls and without austerity, but that is typically the final phase before the patient, often too late, is rushed to the IMF.(1)

An important point in Table 3.1 concerns monetary policy. The heterodox programme includes significant monetization as part of stabilization, but recognizes the need for fiscal austerity. By contrast the orthodox IMF programme emphasizes monetary and fiscal restraint.