**Plc,Plannlng, and Research**

# **Mcocnomic Adjustment and Growth**

The Israeli stabilization program of 198S is generally considered one of the most successful such programs in years. Under it, the inflation rate plummeted from about 400 percent a year to about 15-20 percent a year.

Leiderman and Liviatan examined how stabilization affected other key economic variables after 1985. They were particularly struck by the immediate, abrupt reduction in the rate of inflation and the timing and impact of disinflation on other real variables.

For more than two years after the program, a private consumption boom was accompanied by increased economic activity, relatively high real wages and real interest rates, and a low (appreciated) real exchange rate.

Only in the beginning of the fourth year after t1.e program did the consumption boom stop, economic activity become stagnant, and the rate of unemployment rise.

but will allow an increase in long-term growth after adjustment is completed.

What implications does the Israeli program - a laboratory experiment in heterodox policy - have for the debate about gradualism versus shock treatment in the process of stabilization?

In reducing inflation, the program seems to have had the same effectiveness as other shock treatment programs: there was a sharp and immediate disinflation. This was probably because multiple nominal targets (such as a fixed exchange rate and price-wage controls) were used in conjunction with adjustments in fundamentals, right from the start. This mix makes the pro-ram heterodox.

In terms of the real costs of disinflation, the program may seem more gradualist. The real costs, in terms of increased unemployment, were postponed for several years and in the transition there was actually a boom in economic activity.

The consumption boom seems closely related to the possibility that the program and the fixed exchange rate policy partially lacked credibility. Apparently the pubiic perceived the changes as mainly temporary.

The recent rise in unemployment seems largely to reflect the beginning of a process of _structural adjustment_ whereby resources are reallocated across the economy to conform to the new low inflation equilibrium. This process may involve less growth in the transitional stage Which of these results are peculiar to Israel and which are common to heterodox policies generally is a question worth addressing.

Method: Using simple times series techniques applied to monthly data for 1980-88, Leiderman and Liviatan investigated changes in the time series properties of key macroeconomic variables in 1985 and after. They focused especially on changes in the tradeoff between inflation and unemployment.

This paper is a product of the Macroeconomic Adjustment and Growth Division, Country Economics Department. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Raquel Luz, room N 11 - 059, extension 61588 (56 pages with figures and tables).

The PPR Working Paper Series disseminates the findings of work under way in the Bank's Policy, Planning, and Research **C'-** nplex. An objective of the series is to get these findings out quickly, even if presentations are less than fully polished. Tnte findings, interpretations, and conclusions in thesc papers do not necessarily represent offici.l policy of the Bank.

Produced at the PPR Dissemination Center