## **Plc,Planning, and Research**

# **jMacroeconomic Adjustment l and Growth**

H-eerodox stabilization programs combine tight monetary anld fiscal policies, characteristic of the orthodox appi-oach, with wage and price controls.

Hcicrodox programs arc usually adopted as an altcrnative to orthodox prograins to minimize the costs of bringing down inflation. The hlcterodox approach can bring inflation down rapidly without largc costs in thc short run (the clsx: p.art of th:e program). The costs arc bome latei wlhctn the autlhorities have to concentrate on sustainirln low infationi. Thc magnitude of these cosIS is not yCet clear.

WVhether Lhe stabilization program should adopt a gradual or slhock strategy depends on the rate ol inflation bcfetre stabilization. The ortlhodox shock is most effcctive for stopping h\per;nflation. In economies with chronic, high intlalion, a. hcterodox snock strategy is generally _m_ ore a;i-,; op **atc.** 1I h. quick initild success of hietcrodox piograrnis increases support for thc program, **opeinin** the possibility for adding fiscal mcasLrcs to dccpe_n the stabilization cffort.

**l** iiis opportunity is usually lorgonie, however. I.nracl and Mexico introduced furthler fiscal aidjustr-ment during this phase. In telC Austral and Cruzado plans (in Argentina ard Brazil), thc initial sulcccss was takenI as evidence that morc fiscal adjustment was not required (or could be

postponed), **and** the stabilization effort collapsed.

A gradual approach - such as the onc used in Argentina and Brazil in the 1960s - is more appropriate for economies with low inflation, wAhere the case for income policies is much weaker.

Tight fiscal policy is critical to the success of a heterodox program - particularly during the flexibilization period in which price and wage controls are removed. In the failures of the 1960s and the 1980s, the budget situation had alrcady deteriorated when controls were removed. A relaxed fiscal stance during the freeze led to a sharp acceleration of inflation later.

It is also important to maintain a strong nominal anchor, before and during flexibilization. In Israel, for example, using the exchange rate as the main nominal anchor during flexibilization heiped prevent a rekindling of inflation (at thc cost of overvaluing the currency). The flexibilization period is the most critical timC in a heterodox program, but policymakers do not perceive this. The strategy for getting out of the freez,e is perhaps the most important and difficult part of a hetcrodox program. Heterodox programs fail not because income policies arc poorly designed but because the fiscal effort does nct persist.

I'ld.s papcr is a product of the Mlacrocconomic Adjustment and Growth Division, Countiy Economlics Departmnct. Copies arc available frce from the World Bank, 1818 fl Strect NW, Waslhington DC 20433. Pleasc contact Raquel Luz, room N 1- 057, extension 61,588 (79 pages with figures and tables).

> 1T. ITR 'ol.lirg Paper Series disseminates the findings of vork under way in the Bank's Policy, Planning, and **Rcsearch**

> ( .^ n.l. k An (hiective of Lhe scrics is to get these findings out quickly, even if presentations are less than fully polished. Thc **filulaugs,** icrtprcttion.s. and concltusionis in these papers do not necessarily reprcsent official policy of the Bank.

Pliodud cz at **tlie** PPR DisseminaLion Center