metadata: authors: 0: author: Kiguel, Miguel A.
1: author: Liviatan, Nissan
count: Peru,Brazil,Argentina
docna: 0: docna: Stopping three big inflations (Argentina,
            Brazil, and Peru)
docty: Policy Research Working Paper
subtopic: Public Health Promotion,International Trade and Trade Rules,Inflation,Macroeconomic Management,Armed Conflict
teratopic: Public Sector Development
abstracts: cdata!: Much existing literature fails to
            recognize that high inflation (annual rates in three digits)
            is a distinctly different phenomenon from moderate inflation
            and hyperinflation. The failure to understand the specific
            features of the inflation process in the chronic high
            inflation economies has many times led to a wrong diagnosis
            of the underlying reasons for changes in inflation in those
            economies, and the policies needed to stabilize prices in
            those countries. This lack of understanding extends to the
            interpretations of the recent hyperinflation in some
            economies. Argentina, Brazil, and Peru in the 1980s were
            certainly high-inflation countries. The recent episodes of
            hyperinflation in these countries were not isolated -
            instead, they were the culmination of an unstable process,
            in which inflation crept up gradually for many years before
            accelerating explosively. These episodes were important
            because they helped to dispel the myth that it is possible
            to maintain a stable high rate of inflation on a long-term
            basis without harmful effects on growth. The causes of the
            new hyperinflations were not as clear as in the classical
            episodes, as they originated from a combination of fiscal
            and nonfiscal factors. The chronic fiscal imbalances
            eventually became an insurmountable obstacle, and inflation
            moved away from the fragile high inflation equilibrium into
            hyperinflation. The interesting feature of the new episodes
            (especially in Argentina and Brazil) is that they were not
            triggered by a large increase in the budget deficit;
            instead, because the initial equilibrium was so fragile,
            inflation was in the end destabilized by financial shocks.
            One important lesson of the new hyperinflations is that the
            process of restoring price stability has been longer and
            more costly than in the classical cases. The main reasons
            for this has been that it was not clear in the minds of the
            public where inflation would settle once hyperinflation was
            stopped. In the classic hyperinflations of Europe in the
            1920s, expectations were that inflation would return to the
            low levels that had prevailed before. In the new episodes,
            there is no compelling reason for agents to expect that the
            economy would go back to low inflation. Experience showed
            that inflationary expectations initially settled near the
            level where inflation was prior to hyperinflation. As a
            result, the disinflation process must continue once
            hyperinflation is stopped.
geo_reg_key: 119228,517191
repnme: repnme: Stopping three big inflations (Argentina,
            Brazil, and Peru)
display_title: Stopping three big inflations
            (Argentina, Brazil, and Peru)
listing_relative_url: /research/1992/10/699571/stopping-three-big-inflations-argentina-brazil-peru
topicv3: Inflation m1326709 0870F4727ACED1CF8525815C00471347,Trade m1326924 698,Political Violence and War m1327310 2462,Pandemics m1327520 2167,Deflation m1505334 3102
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Public Sector Development
origu: Policy Research Department
no_of_pages: 58
model_extractions: <!-- Start of picture text --> Policy Research|<br><!-- End of picture text -->

<!-- Start of picture text --> Transition and Macro-Adjustment<br><!-- End of picture text -->

**WPS** 999

This papera product of the Transition and Macro-Adjustment Division, Country Economics Department-is part of a largereffort inthe department to examine stabilization policies. The research was funded by the Bank's Research Support Budget under research project "Stopping High Inflation" (RPO 674-24). Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Raquel Luz, room Ni 1-059, extension 34303 (October 1992, 52 pages).

Much existing literature fails to recognize that high inflation (annual rates in three digits) is a distinctly different phenomenon from moderate inflation and hyperinflation. The failure to understand the specific features of the inflation process in the chronic high inflation economies has many times led to a wrong diagnosis of the underlying reasons for changes in inflation in 'hose economies, and the policies needed to stabilize prices in those countries. This lack of understanding extends to the interpretations of the recent hyperinflation in some economies.

Argentina, Brazil, and Peru in the 1980s were certainly high-inflation countries. The recent episodes of hyperinflation in these countries were not isolated - instead, they were the culmination of an unstable process, in which inflation crept up gradually for many years before accelerating explosively. These episodes were important because they helped to dispel the myth that it is possible to maintain a stable high rate of inflation on a long-term basis without harmful effects on growth.

The causes of the new hyperinflations were not as clear as in the classical episodes, as they originated from a combination of fiscal and nonfiscal factors. The chronic fiscal imbalances eventually became an insurmountable obstacle, and inflation moved away from the fragile high inflation equilibrium into hyperinflation, The interesting feature of the new episodes (especially in Argentina and Brazil) is that they were not triggered by a large increase in the budget deficit; instead, because the initial equilibrium was so fragile, inflation was in the end destabilized by financial shocks.

One important lesson of the new hyperinflations is that the process of restoring price. stability has been longer and more costly than in the classical cases. The main reason for this has been that it was not clear in the minds of the public where inflation would settle once hyperinflation was stopped. In the classic hyperinflations of Europe in the 1920s, expectations were that inflation would return to the low levels that had prevailed before. In the new episodes, there is no compelling reason for agents to expect that the economy would go back to low inflation. Experience showed that inflationary expectations initially settled near the level where inflation was prior to hyperinflation. As a result, the disinflation process must continue once hvperinflation is stopped.

The Policy Research Working Paper Series disseminate the findings of work under way in the Bank. An objective of the series is to get these fndings out quickly, even if presentations are less than fully polished. The findings, interpretations, and conclusions in these papers do not necessarily represent official Bank policy.

Produced by the Policy Research Dissemination Center
# **Stopping Three Big Inflations**

(ARGENTINA, BRAZIL AND PERU) Miguel A. Rguel The World Bank and Nissan Liviatan The World Bank and Hebrsw University of Jerusalem The views expressed in this paper do not necessarily reflect those of the World Bank or Its affiliated institutions. We are grateful to Jamas Benson, Leonardo Leiderman, Michael Michasly and participants at the conference on Stabilization and the Recovery of Growth, held at the Di Tella Institute In Buenos **Aires and at the** Development Workshop at the University of **Montreal** for helpful coiints, and to Heidi **Zia** and Pranclsca Castro for **research assistance.**
# Table of Contents

|I.|Introduction|I|
|---|---|---|
|II.|Basic Features of Inflation|3|
|III.|The Classical Hyperinflations|7|
||The Origins of the Hyperinflations<br>Stopping the Classical Hyperinflations|7<br>12|
|IV.|Origins<br>of the New Hyperinflations in Argentina, Brazil, and Peru|16|
||i.<br>The Background of High Inflation<br>ii.<br>Direct Origir.s of the Recent Hyperinflations|16<br>24|
|V'.|Programs to Stop Three Big Inflations|31|
||i.<br>Basic Features of the Programs|31|
||ii.<br>Classic Stabilization Programs with Non-Classic Outcomes|33|
||iii.<br>Why Has Inflation Been So Persistent?|39|
||iv.<br>Was There A Change of Regime?|41|
|VI.|Final Remarks|46|
|Refer|nces|49|

|References|
|---|
# Stoggina Three pig Iflations,

# 1. Introduction

The recent hyperinflations in Argentina, Brazil and Peru defy much of the widely accepted views regarding the origins and ends of hyperinflations. These "classical" views essentially state that hyperinflations have clear causes, excepttonally large budget deficits financed by money creation, and are brought to a sudden end, through a comprehensive stabilization program. In addition, the stabilization is achieved without much costs in terms of growth and unemployment. Sargent (1982) provides convincing empirical evidence for these propositions based on the European hyperinflations in the mid-twenties. The more recent hyperinflation and stabilization in Bolivia by and large conforms with this view.<sup>1</sup> In contrast, the more recent hyperinflations in Argentina and Brazil have less clear origins. Prior to the hyperinflation, deficits, while large, did not reach enormous proportions while seigniorage levels were not higher than in the previous two decades. The fiscal situation did not reach the crisis proportions of the classical hyperinflations. Instead, these hyperinflations appear to have been the final stage of a long process of high and increasing rates of inflation, in which a finalexplosion was all but unavoidable. The origins of the Peruvian hyperinflation, on the other hand, is more similar to the classical episodes.

The process of stopping hyperinflation is also much more cumbersome than in the classical cases. While experiences varied from country to country, a quick glance at the episodes suggests that policies that have much in common to those that were successful in stopping hyperinflation in lts tracks in Europe and in Bolivia, did not yield the **same** outcomes in **the** recent three episodes. Although these countries also adopted orthodox stabilization program. of different intensities, based on fiscal balance **and** I The Bolivian hyperinflation and the ensuing stabilization is described in Sachs (1986) and Morales (1988) among others.
2 tight money, and some of the programs went a long way in demonst ating a change of regime of the type discussed by Sargent, the results were mixed. They all succeeded in stabllizing the exchange rate and in bringing down inflation drastically from the peak of the hyperinflation; however, Inflation did not stop in its tracks, instead, in the more successful cases it remained stuck for a while at rates that on average ranged from 5 to 10 percent a month, while there were some bouts of high inflation. The programs did not succeed in stabilizing prices in the same way as after the classical hyperinflations did.

This paper will examine the main reasons for the differences between the classical and the new hyperinflations regarding their origins, and the characteristics of the stabilization process that brought them to an end. We recognize that the recent hyperinflations do not constitute a perfectly homogenoue group. Nevertheless, in broad terms there are distinctive features which are observed to different degrees in the new episodes that stand in sharp contrast with the classical hyperinflations.

A central message of this paper is that the recent episodes were different because they took place in countries that had a relatively long history of high inflation. Once inflation is high, it can be destabilized into a hyperinflationary path even by relatively smilll shocks. Likewise, the process of bringing down inflation is generally longer and it is more difficult to sustain in these countries. Previous failed stabilizations undermines the credibility of a new program. It takes time and persistence to convince the public that prices will be stabilized on a long term basis.

We will also argue that by _and_ large, in the recent episodes countries had more control over the inflation process, as well as on the damaging effects of inflation. Brazil and Peru, for example, experienced high rates of inflation (between 20 and 49 percent per month) for prolonged periods without facing a full blown acceleration. This ability to maintain these extreme inflation rates within bounds is unique to these high inflation economies. Likewise, the ability to limit the damaging effects of inflation
3 in evidenced by the evolution of tax revenues during hyperinflation In the classical epi$odes hyperinflatLon Lnduced a collapse of tax revenues (as a result of the Olivera-Tansz effect). In contrast, Argentina and Brazil were able to limit the fLcal damage of hyperinflation.

The paper iL organiLad **as** follows. SectLon II presents some basic facts about the behavior of LnflatLon in the episodes that we study, and show that Brazil and Peru had **more** control over Lnflation than the other epLodes included in our study. SectLon III examines the wholeg process of hyperinflatLon and stabilizatLon ln the classic hyperinflations, wlth especial attentlon on the o livian **case.** Section IV will concentrate on the causes of the hyperlnflations in Argentina, Brazil and Peru. It is argued that the new opisodes **are** indeed of a different nature, mainly because they took place in countries with a tradition of high inflation. We of course recognize that there were clear differences within this group. Peru has more similarities with traditional **epLsodes** regarding the causes, though it managed to avold a full acceleration of inflation. In Argentlna and BrazlI the hyperinflation was triggered by different forces. Section V investigates Ln what respects the recent stabLilzation process in Argencina, Brazil and Peru can be considered as a de Parture from previous, less comprehensive stabilization attempts, and to what extent can we consider them as representing a change of regime. We also briefly examine the impact of these programs on inflation, and **discuss the** differences with the classical hyperinflations. **We** conclude in section VI with some final remarks.

# II. Basic Fgatures of InflatLon

Table illlustrates som of the differences between the classical and the new hyper$nflatlons.2 **We** used Cagan's criterion for determining the beginning and end of a hyperinflation. In his own words "I shall define hyperinflations as beginning ln **the** month the rise in prices exceeds 50 2 The tables A.1 and A.2 at the end of the paper provide more detailed data of the evolution of inflation.
4 percent and ending ln the month before the rise in prices drops below that amount and stays below for at least a year" (Cagan 1956), p.<sup>2</sup> 5). In most cases it is easy to establish the beginning and end of the episodes. Peru is the only grey area in our sample because although inflation reached 114 percent in September 1988, the next month it fell below Cagan's 50 percent benchmark and remained at the lower level for almost two yeard. Thus, if we use Cagan's definition in a strzct sense, Peru experienced 2 hyperinflations one Ln 1988, that lasted just one month, and another Ln 1990, this one for two months. However, we do not think that this would be a good representatlon of what happoned. The fact that Peru did not experience a full blown hyperinflation at that time was maLnly a fluke, since it was on the verge of it in several occasions. In this paper we take the viow that Peru's hyperinflation started in September 1988 and analyzed it in this fashion.<sup>3</sup> 3 In table 3, on the other hand, we follow Cagan's definition strictly, so we show that the hyperinflation was shorter.
5 TABLE 1

|1<br>_ _<br>_ _<br>_ _<br>_ _<br>_|l<br>(1)<br>Approximate<br>Beginning<br>_________|(2)<br> <br>Approx.<br>Duration<br>__________|(3)<br># of Months<br> <br>Inflation<br>Above 50%|(4)<br> <br>hyper-<br>inflation<br>Cycles<br>___________|(5)<br>#of Months<br> <br>Inflation<br>Between<br>20 and 49%|
|---|---|---|---|---|---|
|AUSTRIA|10/ 1921|12 months|<br>6|3|7|
|BOLIVIA|04/<br>1984|18 months|9|4|10|
|GERMANY|08/ 1923|17 months|<br>14|3|7|
|HUNGARY|03/1923|12 months|<br>5|3|a|
|POLAND|01/ 1923|13 months|<br>9|3|7|
|ARGENTINA|05/ 1989|11 months|6|2|5|
|BRAZIL|12/ 1989|4 months|4|1'|15|
|PERU|07/ 1990|2 months|2|1|25|

A comparison of these episodes indicates that the classical hyperinflations were by and large longer, and more extreme than those of Brazil and Peru. Argentina, is the only recent episode where the pattern of inflation is similar to the classical episodes. The second column of table 1 indicates the duration of these episodes. Bolivia is the longer within this group, it lasted for 18 months, while the shorter of the classical hyperinflations were Austria and Hungary (12 months). ArgentLna comes close, as it lasted for 11 months. The new hyperinflations in Brazil and Peru were much shorter. In Brazil it only lasted four months, in Peru it lasted it was short, although it was on the verge of it for a long time.

There is also a distinction regarding the intensity of the episodes. Germany is unique in our sample for the exorbitantly high inflation rates. But even abstracting from that case, it is clear that the other classical
**6**

episodes were more extreme than Peru or Brasil, while<sup>Argentina is not clear</sup> cut. Three crude indicators are the number of months<sup>in which inflation</sup> exceeded Cagan's 50% benchmark, the number of **extreme** inflatLonary<sup>bouts</sup> within the whole span of each hyperinflationary **eplsode,** and the ablilty, or lack of it, to maLntaln inflation below 501 for prolonged perlod. Accordlng to the first lndicator, described Ln column (3), tho classical<sup>epLodes were</sup> more extreme, as inflation exceeded the 50 percent benchmark 14 months<sup>Ln</sup> Germany, and 9 months in Bolivia and Poland. Argentina L simllar to Austrla and Hungary. At the other extreme we fLnd Peru, where LnflatLon exceeded 50 percent for only 2 months Ln 1990 and for 1 month ln 1988.

A second feature is the number of **episodes** Ln whlch lnflation started below the 50 percent per month threshold and later on exceeded it. The reductLons 'n inflation below 50 percent (after **the** inLtLal rise) were usually associated with unsuccessful stabLlizatLon attempts.<sup>This measure</sup> indLcatos the ability of the authorities to keep the process<sup>under "limited"</sup> control, the larger the number of accelerations, the<sup>more diffLcult it was to</sup> avoLd a full explosLon of Lnflation. Column (4) shows<sup>that there were fewer</sup> cycles in **the** recent epLsodes thus LndLcating that the<sup>authorities were able</sup> to contain Lnflation better than in the classical ones.

FLnally, column (5) shows the number of months when inflation<sup>remained</sup> ln the high ranges, but below Cagan's hyperlnflatLon level.<sup>Once again, the</sup> numbers Lndicate a clear distinction between **the** classical episodes<sup>and</sup> Argentina on the one hand, and Brazil and Peru on the other.<sup>The latter</sup> countries were able to exert much better control over<sup>high inflation, in the</sup> sense that these high rates did not explode Lato hyperinflatLon<sup>territory.'</sup>
7 The overall impresoion conveyed by table 1 is that in the new episodes (as a grour), the authorities were able to exert more control over inflation, and managed to lLmit the real negative effects of Lnflations.

# III. The Classical Hvoerinflations

# The Oriains of the Hvoerinflations

The European hyperinflations of the 1920a (in Austria, Germany, Hungary, Poland and Russia) and the more recent hyperinflation in Bolivia constitute the sample of what we call classical hyperinflations (CH). The most distinctLve feature of these episodea is that they had clear origins (large budget deficits financed by money creation), and that they were stopped suddenly, by an orthodox program that addressed the fiscal imbalance, and convinced the public that the central bank would not print money to finance the budget deficit.

The origins of these large deficits wers clear and typically resulted from unusual circumstances. In the 1920s they were linked to the costs of reconstruction and to the war reparation payments in the losing countries, while in Bolivia it was directly related to a sudden halt in the avaiLability of external financing in a situation in which the country could not produce a sufficiently large fiscal adjustment to service its external obligations.

The background of the hyperinflations in the 1920c was the end of World War I. The losing countries ended up owing reparations to the allies while they underwent major domestic instability, which in many cases included difficulties in establishing and securing the countries borders. Germany had the heaviest burden of reparation payments, Austria, lnherited the largest part of the bureaucracy from the old Austro-Hungarian empire and not enough
resources to finance them, Hungary underwent dramatic political instability, including a brief communist regime, and wars with Czechoslovakia and **Rumania.** Poland became a new nation after the War, and had to fight Russia to **secure** its borders.

The hyperinflations of the 1920a thus took place under unusual circumstances, in countries that were devastated by the effects of the War. Domestic factors --namely political instability and large deficLts-- worked in conjunction with external ones --the burden of reparatLon payments and unsecured borders-- to generate a especial environment for the extreme phenomenon of hyperinflation.

The more recent hyperinflatlon in 8olLvia was linked to a severs external shock: a sudden and important reduction ln the availability of external financing (see Sachs (1986) and Morales (1987a)). During most of the seventies and early elghties Bolivia received positive external net resource tran3fers as net new lending exceeded net interest payments. The situation took a drastic turn in 1982 and by 1983 net external resource transfers, which had already turned negative in 1982, reached -5.6 percent of GDP (see table 2). This external transfer (as a share of GDP) was larger than the cash reparations payments required from Germany after World War It The unusually adverse circumstances described in all these episodes created conditions that were especially favorable for the emergence of hyperLnflation.

There ia little dispute that the classical hyperinflations were caused by large budget deficits financed primarily by money creation. Table 3 shows some fiscal indicators for the clas4ical hyperinflations. Two features **are** clear. First, in all cases revenues were only covering a small fractlon of total expenditures. In Europe, tax revenues covered less than half of
**Table 2**

# Bolivia: Annual Indicators

|1470-1974<br>1975-1979|<br>~21.68<br>10.14|4.40<br>_4.08_|2.02<br>2.98|10.82<br>1Q0|__1.46||578|5-75<br>|62.04<br>|113.03<br>|3.17 *|
|---|---|---|---|---|---|---|---|---|---|---|---|
|1980-1982|69.73|-1.47|S.77|<br>9.93|_<br>453|_<br>997|-.<br>327|0.08<br>|_32.00_<br>|101.3<br>|_5.14_|
|1983|269.00|-4.50|9.70|<br>7.24|.<br>4330|.<br>1870|-.<br>_240_|444<br>|94.90<br>|79.70<br>|0.93|
|1984|1281.40|-0.60|15.80|<br>5.15|.<br>4600|.<br>2510|_-._<br>270|3.97<br>|88.80<br>|73.78<br>|-4.28|
|1985|11749.60|-1.00|.30|<br>3.04|.<br>2390|.<br>1010|-.<br>550|4.90<br>|88.30<br>|68.39<br>|*4.84|
|1986|276.30|-2.50|2.50|<br>3.37|.<br>2290|.<br>340|-.<br>990|3.14<br>|84.40<br>|27.67<br>|-5.32|
|1987|14.60|2.60|1.07|<br>4.64|.<br>2410|.<br>780|-.<br>990|-1.31<br>|61.40<br>|106.08<br>|0.50<br>|
|1988|16.00|2.96|3.83|<br>5.20|.<br>2780|.<br>660|-.<br>690|-2.96<br>|50.50<br>|106.68<br>|4.45|
|1989|15.00|2.72|1.95|<br>5.44|.<br>2780|.<br>500|-.<br>580|-1.09<br>|57.00<br>|116.25<br>|0.44|
|1990|17.12|2.71|2.13|<br>5.57|.<br>2780|.<br>330|-.<br>450|-0.13<br>|59.10<br>|123.17<br>|_0.40_<br>|
||||||.|.|-.|1.23|n|132.44|-0.00|

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10 governmenc expenditures, and at the peak of the hyperinflation revenues represented just 12 percent of expenditures in Germany and 16 percent in Austria. In Bolivia, government revenues fell from around 85 percent of revenues in 1980 to around 50 percent for the period 1983-85. Second, there was a collapse of government revenues coinciding with the rise in inflation (an extreme form of the Olivera-Tanzi effect). At the height of the hyperinflation revenues in Germany were around one third of what they were before. Likewise, in Bolivia revenues plummeted from 32 percent of GDP in 1982 to just 13 percent in 198S. The collapse in tax revenues was more dramatic, as they fell from 8 to 3 percent of GDP between 1981 and 1983 as inflation increased from 30 to 270 percent. As we will show in the next section, these features were extreme in the recent hyperinflations.

Seigniorage was extremely large in the classical hyeprinflations. Figure 1 shows estimates of the revenue from money creation for Germany and Bolivia. What happened in Bolivia is well known, seigniorage increased fivefold from around 2 percent of GDP in 1979-81 to over 10 percent of GDP in 1983-85. In Germany seigniorage4 increased six fold at the outbreak of the War, and remained high till the end of the hyperinflation. In both episodes the level of seigniorage was too large, in the sense that it lied above the Laffer curve, and hence it could not be financed by any stable (no matter how high) rate of inflation. The result was hyperinflation.5 An important feature of these episodes is that the rise in seigniorage preceded the actual emergence of hyperinflation. This evidence is consistent 4 Seigniorage in Bolivia is calculated as the change in money based relative to GDP. In Germany we do not have reliable data on GDP, so we approximated seigniorage by the change in base money deflated by the average price level.

5 This issue is discussed more extensively in Kiguel and Liviatan (1988).
11 Figure 1

# BOLIA

<!-- Start of picture text --> 12500 17.5<br>* 18~~~~~~~L.0<br>10000 / '.<br>:N<br>75 g\-....... 10 .0<br>500 -<br>2500 ........... - .*o2<br>0 t25~~~~~~~~~~~~~~~L. *-0.0<br>78 79 80 8L 62 63 84 85 as 87 88 89 90<br><!-- End of picture text --> GERMANY, INFLATION AND SEIGNIORAGE <!-- Start of picture text --> LZ~~~~~~~~~~~~~~~~~~<br>75o . ....................... 1..................<br>11 12 13 i4 iS 16 i7 LB LO 2.0 21 22 23 24. 25 26<br><!-- End of picture text --> <!-- Start of picture text --> . .1-.intlatioa - sei9nio=r&9c<br><!-- End of picture text -->
12 with our view that excessive seigniorage led to an acceleration of inflation. In Bolivia, for instance, the increase.in seigniorage occurred in 1982 while the hyperinflation became apparent only 1984. The picture is less clear in Germany, because the lag was much longer. A protracted period of very high seigniorage eventually led to the hyperinflation. Annual data indicates, however, that inflation entered into an accelerating trend around 1917, but became unstoppable only in the second half of 1922.

Finally, it is important to keep in mind that the CH took place in countries where high inflation was the exception rather than the rule. The hyperinflations of the twenties occurred when the world was by and large operating under the gold standard, and in an environment where price deflation was not unusual. The norm was definitely low inflation. Likewise, inflation in Bolivia during the sixties and seventies was moderate by Latin American standards. The worse inflationary episodes occurred in the midfifties when the annual inflation rate remained above 100 percent for a couple of years. Since then inflation remained fairly low; evidence of this was the fact that the country was on a fixed exchange rate regime since 1959 (with only two devaluations till 1982).

# StoDDina the Classical Hyperinflations

The classical hyperinflations were stopped always and everywhere abruptly through a comprehensive program that stabilized the exchange rate, reduced the budget deficit sharply, and send a clear signal that the Central Bank would end domestic credit to the government. In Germany, the exchange rate was stabilized on November 20th, and prices stabilized the following week.<sup>6</sup> Likewise, the hyperinflation in Bolivia was stopped in its tracks, 6 See data in Webb (1986) p.788.
13 the exchange rate was stabilized on August<sup>29, and during the second week of</sup> September the economy experienced deflation.

The stabilization programs that brought<sup>the European hyperinflations</sup> to a sudden end are extensively discussed in existing<sup>works such as Sargent</sup> (1982), and Dornbusch and Fischer (1986)<sup>among others. In all cases the</sup> success was based on fixing the exchange<sup>rate, balancing the budget, and</sup> making a credible commitment to stopping central<sup>bank financing of the</sup> deficit (this was usually done by creating<sup>an independent central bank).</sup> External support was critical in these cases,<sup>because a large part of the</sup> fiscal deficits xesulted from the war reparation<sup>payments.</sup> The Bolivian hyperinflation was also<sup>brought to a quick end, by a</sup> stabilization program based on a firm commitment<sup>to balance the budget on a</sup> cash basis, and a policy of tight money<sup>to stabilize the exchange rate and</sup> prices. As shown in Sachs (1986) the program succeeded<sup>immediately in</sup> stabilizing the exchange rate, and as a result,<sup>very quickly hyperinflation</sup> came to an end. In this respect, the outcomes<sup>were similar to the</sup> stabilization programs that ended the European<sup>hyperinflations in the mid-</sup> twenties and after World War 11.

The success in stopping hyperinflation did not require balancing the budget on a longer term basis, though it was<sup>necessary to signal</sup> unequivocally that the central bank would not<sup>issue money to finance the</sup> deficit. In fact, after an initial period<sup>inwhichthe government ran a</sup> balanced budget, deficits have remained relatively<sup>large without becoming a</sup> destabilizing force. Once the government establishes<sup>its determination to</sup> sustain price stability, it can run budget deficits<sup>which are consistent with</sup> the availability of non-inflationary finance. In Bolivia, the deficits were mainly financed externally without resorting to<sup>seigniorage (which, as can be</sup>
14

**seen** from table 2, fell to pre-hyperinflations levels of around 1.5% of oDP). The Austrian stabliLzatLon of **the** 1920# provides another illustration of the complexLtles of the role of the budget deficit in stopping hyperinflatlon. In that **episode, the** government continued to run deficits ln 1923 (as shown in table 3), for a whole year after the end of the hyperinflation. N **verthel-os,** thLs was not a source of inflatLon, mainly because the stabliLation package was comprehensive enough to remove uncertainty regarding the commitment to the new regime.

A common feature to all the programs that succeeded in stopping hyperinflation was their ability to signal a change of regime (as argued in gargent). In the 1920s this typically **was** done by a stabilization package with external support. Thli was critical because ln the absence of a reoolution of the reparation payments, there **was** no way to ensure a strong fiscal position. The programs of the 1920c also included the creation of an independent central bank, thus removing the abillty to finance defLcits through money creation. The creatLon of the Lndepandent central bank would have not been possiblo (nor crodiblo) in the absence of clear indications that the budget would be balanced. in Bolivia the change of regime was **leos** clear Lnitially (see Sachs on this Lssue). On the fLical slde a key actlon was the creatLon of a cash committee whose maln task was to maintain a balanced budget on a cash basis. This was suMported by the reestabllshment of exte-nal lendLng, and by far reaching structural reforms that signaled a departure from past lnflationary practLcos. Nevertheless, Bolvla dld not go as far as the Buropean countries in reformLng the central bank. The end of the hyperLnflation in BolivLa provides mixed signals of tfie success of the program in changLng long term expectations. The persistence of high real Lntereot rates and the slow remonotizatLon of the economy are
15

# TABLE 3 POLAND, AUSTRIA, GERMANY AND BOLIVIA CLASSICAL HYPERINFLATIONS

|||=<br>**S**|<br>**55**<br>M|=I<br>**S**<br>**W'**||
|---|---|---|---|---|---|
|_POLAND_|1921|880852|345311.0|0.39202|126.9|
||1922|879313|530428.0|0.60323|212.0|
||1923|1119800|426000.0|0.38043|156380|
||1924|1829000|1703000.0|1.04543|n.a.|
||1925|1981593|1981884.0|1.00015|6.8/l|
|_AUSTRIA_|1919|1309|632.3|0.48308|n.a.|
||1920|1089|168.0|0.15248|n.a.|
||1921|660|197.0|0.29653|842.0|
||1922|733|118.0|0.15830|3132.2|
||1923|367|2se.6|0.70000|135.6|
|_GERMANY_|<br>1920|11266|4223.7|0.37492|257.4|
||1921|11963|5336.2|0.44e04|28.7|
||1922|9965|3580.5|0.35931|1688.3|
||_1923_|13513|1676.7|0.12408|8.7E+10|

|_BOLIVIA /2_|1980|48.30|40.50|9.70|0.83851|47|
|---|---|---|---|---|---|---|
||1981|38.90|32.00|8.30|0.82262|29|
||1982|49.40|34.10|5.00|0.69028|133|
||1983|43.30|24.60|3.40|0.56813|269|
||1984|46.00|21.00|2.20|0.45652|1281|
||1985|23.90|13.90|2.90|0.58159|11750|
||1986|22.90|19.40|4.50|0.84718|278|
||1987|24.10|16.20|6.20|0.67220|15|

_SOURCES:_ _POLAND, Sargent. AUSTRIA Dornbush & Fischer. GERMANY. Young. BOLIVIA Country Economic Memorandum._ _/i : December rate of change over the three months preceding. 12 : Total expenditures and Revenues as % GDP._
16 just some indicators of the difficulties in reversing long term expectations. While they came down from the extremely high levels that prevailed during the first year (of around 100 percent), they are still very high by lnternational standards (exceeding 20 percent per year). Also puzzling is the very small lncrease in real money balances. By 1989 with an inflation of just 15 percent, MI as a share of GDP was slightly larger than at the peak of the hyperinflatlon. This slow remonetlzation of the Bolivian economy stands in sharp contrast with the rapid Lncrease in real money balances ln the 1920s. Money supply increased dramatically once prlce stability was achieved. These expansions in the money supply were not lnflationary, as they accommodated a rapid increase in money demand.

# IV. OriaLne of the New Hvgerinflations in Argentina. Bra&il and Peru

# l. The Background of Hich Inflation

The more recent hyperinflations occurred in countries with a long tradition of high inflation (see tables 5.a to 5.c). Argentina had continuously experienced three digit annual rates of inflation since the midseventies. In Brazil annual inflation was already at 40 percent in the midseventies and reached three digit. in the early eighties. Peru started to experience high inflation later, in the second half of the seventies, but by the early eighties it was also suffering from inflation rAtes in the three dlgits.

This long history of inflation had its roots in large budget deficits and the continuous growth of the public sector. As shown in table 3, budget deficits were already very large in Argentina and Peru in the early seventies, while in Brazil they became large in the second half of the
17 decade. In addition, the size<sup>of the central government and of public sector</sup> enterprises mushroomed during<sup>the decade. However, in contrast to the</sup> classical episodes, these countries<sup>were able to maintain limited control</sup> over inflation, it did not get out<sup>of hand.</sup> The links between saigniorage<sup>and inflation were not as sharp as ln the</sup> classlcal hyperlnflatlons. Flgure<sup>2 shows annual seLgniorage and lnflation</sup> for theme countries. The contrast<sup>wlth Germany and Bollvla is clear; there</sup> was no slx-fold increase in seigniorage<sup>in any of these countrles.</sup> Selgniorage in Argentina had been<sup>large at least since the early seventLes,</sup> but except for a few short episodes<sup>it never went out of control. The story</sup> in Brazil is even more puzzlLng,<sup>where seigniorage has been relatively</sup> moderate and stable mlnce the seventies.<sup>The increases in inflatLon in 1975,</sup> 1979 and 1982 were not assocLated<sup>wlth any noticeable increases in</sup> seigniorage (which in fact remained<sup>at around 2 percent of GDP). These</sup> increases ln lnflation lnstead resulted<sup>from devaluations that were</sup> accommodated through easy money<sup>and wage indexation. The Peruvlan</sup> experience, on the other hand, is much more simllar to the classLcal episodes, the rise in seigniorage<sup>leads the outbreak of hyperinflatlon.</sup> Their ability to avoid hyperinflation<sup>for such a long time was related</sup> to the development of mechanLims<sup>that allowed them to live with inflation.</sup> We already mentioned that ln the<sup>classical episodes government revenues</sup> collapsed, usually before the<sup>full hyperinflation set in (e.g. in Bolivia tax</sup> revenues more than halved as inflation reached three<sup>digit levels). On the</sup> other hand, Argentina and Brazll<sup>were able to maintain government revenues at</sup> stable levels in spite of the increases<sup>of inflation (see table 4). There is</sup> no notlceable loss of revenues in<sup>Brazil in spite of dramatic increases ln</sup> inflation sLnce 1986. Likewise,<sup>in Argentina, for which we have quarterly</sup>
18 TABLE 4 ARGENTINA, PERU AND BRAZIL HYPERINFLATIONS /1 4 s% GDP)l

|_<br>ARGENTINA<br>1985|42.20|38.82|22.04|0.91660|672.2|
|---|---|---|---|---|---|
|1988|39.18|36.90|21.98|0.94334|90.1|
|167|39.28|33.75|20.81|0.85922|131.3|
|1966|34.08|28.97|16.21|0.85006|343.0|
|1|35.66|26.83|17.39|0.60847|179.9|
|1|34.20|30.50|16.64|0.89181|480.0|
|III|30.50|27.93|15.97|0.91394|954.8|
|IV|36.47|29.19|15.90|0.80038|220.2|
|1980|30.65|27.58|18.16|0.89400|3079.8|
|1|37.15|28.86|15.74|0.77685|189.2|
|1|36.66|26.76|11.52|0.69183|12459.0|
|III|22.49|24.06|14.71|1.06981|198171.2|
|IV|39.01|30.27|17.80|0.84060|350.9|
|1990|20.06|28.07|16.95|1.07713|2314.0|
|1|22.62|21.23|12.35|0.93655|35399.7|
|1|31.28|29.27|17.40|0.93574|1807.3|
|III|30.59|26.88|17.28|0.94410|352.0|
|IV|29.52|26.51|17.13|0.96579|192.1|
|PERU<br>1985|23.50|14.60|14.30|0.62979|163.4|
|1966|21.30|12.60|12.20|0.59155|77.9|
|1987|16.20|9.20|9.30|0.50549|85.8|
|1986|15.60|9.20|9.10|0.5s974|687.0|
|I|18.90|10.90|11.20|0.57672|310.4|
|it|14.00|9.10|9.50|0.65000|424.2|
|III|17.50|7.70|7.90|0.44000|2615.3|
|IV|14.70|9.70|9.30|0.6es8s|8501.3|
|1989|13.20|6.00|0.50|0.454|33398.6|
|1|14.40|9.10|9.40|0.63194|6630.6|
|1I|12.70|7.70|7.90|0.60o|4579.9|
|III|12.40|5.50|6.00|S 0.44355|1362.4|
|IV|13.60|5.70|0.20|0.41912|1527.8|
|1990|14.50|7.80|7.90|0.53793|7481.7|
|1|12.70|4.80|5.00|0.37795|2403.8|
|If|21.30|5.40|5.70|0.25352|3728.5|
|III|13.70|.60|6.70|0.46175|524510.2|
|IV|14.40|8.60|8.70|0.59722|942.4|
|BRAZIL<br>196|29.20|27.10|20.30|0.92608|145.2|
|1967|31.90|27.00|18.O|0.4639|229.7|
|1996|30.70|2830|17.80|0.92182|682.3|
|1989|34.60|26.20|18.40|0.75072|1287.0|
|1990|32.70|31.50|23.90|0.96o30|2937.8|
|1991/4|28.30|27.60|20.30|0.97527|440.8|

# _SOURCES:_

_ARGENINA l Minkt"y ot Economy. PERU, Central Bnk of Peru. BRAZIL, BrazilRacnt economic DOlopmeit /t : Consolidated Public Seor (Brazil and Argentina) Csntral Govemmt (Pe ru) /2 : Total renes exceptfotr Pel tony the current reenue. 13 : The quaterly detae m annumllaed. /4_ : _lotW d_
F?g9ure 2

# INFLATION- SEIGNIORAGE

<!-- Start of picture text --> ARGENTINA<br><!-- End of picture text --> <!-- Start of picture text --> . - --- ..<br>Am ------- ---<br>.e<br><!-- End of picture text --> <!-- Start of picture text --> PERU lfshIn V<br>342 In X9<br>e0e I 10 I<br>M Vr<br>'U.<br><!-- End of picture text --> <!-- Start of picture text --> BUSL In W<br>-<br>A -. I -E0n<br><!-- End of picture text -->
# **Table 5a**

# Argentina: Annual **Indicators**

' 1970-1974 1975-1979 227.58 38.30 3-47 4.60 15.10 1.84 8.36 8.88 45.53 6.84 0.44 2.07 112.44 40.19 4.93 40.35 0.96 141.52 135,50 187.39 -0.07 0.38 1980-1882 123.34 -3.39 5.37 7.07 SO.S1 5.54 -3.47 1.26 96.03 140.59 2.42 198 **3** 43.82 2.92 8.61 5.12 55.59 10.71 -3.77 5.75 96.20 218.85 -0.46 1984 626.72 2.46 7.12 4.01 51.86 7.65 -3.21 5.12 97.00 184.78 -4.58 1985 672.15 -4.38 6.51 3.89 52.09 2.16 -1.46 7.41 89.80 207.83 -6.36 t98B 90.10 5.40 3.46 5.20 50.58 2.22 -3.6 **3** .10 85.30 200.51 -6.04 1987 131.33 1988 342.96 t989 307.a1 Mi~~...~ -3.77 9.00 3.05 33.26 3.27 -2.16 9.47 89.60 -2.72.37 4.03 4.43 50.0 _ANR_ **_.All..'_ 5** .17 3.24 37.53 **_.vp_** ¢) 5.10 -1.75 4.73 86.20 **5** .54 -5.13 1.23 81.80 215.13 222.21 165.25 -4.99-2.54-5.04 1990 23t3.97 -t.96 4.81 2.38 31.08 0.97 2.29 11 **.** 05 n.a 176.09 ;3.57O SNW*-P _Based In Mif. .UNIC Defict .Ovral ff tt, op ot th Con.kfltPul,k ncto. tS701IM FfEL. ON tf..g.l ExWf Ssefot A NOftEX Exchag Rteh :tNomf *xdw rof. odkbf mrket rfof r.a ttS Term of Trade_ T em _dX0 trade_ Indx 100- OD _AHSREt R*ealExchRt Rel fmANf nf W hai rest aindswh rcstMtothp top ImytyradingprNtra 1flS0sStI Hrt_ n" _o Worldf_ Dow _tab/ea, stion tW lorng wm not transfrs truiefrtv ftsF. sterf i n IMS it esxclds rtg trwntf 19: 19371-890 4_
# Table 5b Brazil: Annual Indicators

|1970-1974<br>1975-1979|19.87<br>41.22|11.61<br>5.98|1.53<br>238|15.58<br>11M8|35.79<br>4712||-2.00<br>|-1.04<br>|167.22<br>|69.99<br>|3051')|
|---|---|---|---|---|---|---|---|---|---|---|---|
|1980-1982|95.38|1.75|.<br>201|<br>686|.<br>4826|576|-3.96<br>|-1.26<br>|135.06<br>|73.90<br>|233|
|188S|142.14|3.47|.<br>1.30|.<br>459|.<br>4597|.<br>40|-5.17<br>|-0.16<br>|94.03<br>|88.39<br>|-0.73|
|1984|196.98|5.17|<br>234|.<br>336|.<br>4383|.a<br>270|-3.30<br>|3.14<br>|91.00<br>|100.75<br>|-1.43|
|1985|226.86|<br>8.26|.<br>2.32|.<br>403|.<br>4911|.<br>430|0.02<br>|6.14<br>|94.00<br>|109.85<br>|-1.22|
|1986|145.24|7.54|<br>360|.<br>869|.<br>2920|.<br>360|40.10<br>|5.47<br>|89.10<br>|111.97<br>|-2.80|
|1987|229.68|<br>3.63|.<br>273|.<br>495|.<br>3190|.<br>|-2.00<br>|3.06<br>|110.00<br>|109.31<br>|-3A6|
|1988|682.30|<br>0.01|.<br>341|.<br>307|.<br>3070|5.50<br>480|.0.50<br>|3.68<br>|97.20<br>|100.10|-2.80<br>|
|1989|1288.98|3.60|.<br>502|.<br>225|.<br>3490|.<br>6|1.20<br>|5.47<br>|116.80<br>|91.27<br>|-2.85|
|1990|2937.82|<br>-4.28|.<br>436|.<br>375|.<br>3270|.90<br>130|0.23<br>|3.59<br>|120.10|74.78<br>|-1.72|
||||.|.|.|-.|0.05|2.11|n..|62.60|-0.74|

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# Table **5c**

# **Peru:** Annual Indicators

|1970-1974<br>1975-1979|9.08<br>4394|6.27<br>159|1.53<br>241|14.86<br>|29,08<br>|2.84<br>|-1.21<br>|_1.17_<br>|_6t3.9|3|0.34<br>)|
|---|---|---|---|---|---|---|---|---|---|---|---|
|<br>19841982|.<br>6634|.<br>328|.<br>235|13.45<br>|40.62<br>|6.38<br>|-3.36<br>|-0.06<br>|_|87.80|2.5|
|<br>1983|.<br>11113|.<br>-1264|.<br>287|8.34<br>658|41.41<br>|6.10<br>|-4.63<br>|0.01<br>|123.83<br>|88.78|-1.68|
|<br>1984|.<br>11021|.<br>481|.<br>24S|.<br>55|56.03<br>|10.23<br>|-4.39<br>|1.47<br>|110.60<br>|88.42|2.88|
|<br>1985|.<br>16341|.<br>227|.<br>986|.7<br>|_48.17_<br>|6.51<br>|-1.07<br>|4.82<br>|101.00<br>|88.39|2.34|
|<br>19S6|.<br>7792|.<br>924|.<br>423|6.09<br>|48.30<br>|2.51<br>|0.75<br>|6.50<br>|90.60|1t5.67|-0.82|
|<br>1987|.<br>8585|.<br>831|.<br>574|8.69<br>|39.53<br>|5.20<br>|*4.02<br>|*0.24<br>|66.40|82.31|-1.39|
|<br>1988|.<br>66703|.<br>-822|.<br>789|8.58<br>|34.35<br>|6.90<br>|-3.37<br>|-4.19<br>|66.90|56.98|0.29|
|<br>1989|.<br>339858|.<br>-1161|.<br>610|5.04<br>|34.20<br>|7.59<br>|-2.97<br>|-0.26<br>|74.90|42.52|0.41|
|<br>1990|.<br>748168|.<br>-485|.<br>542|3.43<br>396|23.50<br>|6.16<br>|0.80<br>|3.24<br>|72.50<br>|41.11|0.40|
||.|.|.|.|22.90|3.04|-1.60|0.69|65.00|"AL|0.24|

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23 data, we find that the hyperinflation had only a discernable impact on revenues during the second quarter of 1989. Only in Peru we find some evidence of a fall in revenues, although the most dramatic fall occurred relatively late in the inflation process (between the 3rd quarter of 1989 and second quarter of 1990).

The ability to cope with high inflation, which was absent in the classical episodes, can explain why these economies were able to avoid hyperinflation for a long time. In spite of large budget deficits and short periods of high seigniorage, inflation was high but not exploding. This was possible because revenues did not collapse (as was the case in the classical hyperinflations) and hence the governments were able to take the required fiscal actions to avoid excessive seigniorage and keep inflation within the boundaries of high inflation.

Nevertheless, as time went by and high inflation persisted it became more difficult to avoid hyperinflation. One important development in this respect was the gradual shrinking of money holdings (relative to GDP) over time, which slowly increased the fragility of the financial system. In Argentina, M1 dropped from 14% of GDP in 1970 to just 3% in 1990; likewise, in Brazil, it fell from 16% in the early seventies to just over 3% of GDP in the late eighties (the drop in the monetary base was similar). As a result, the central bank diminished its ability to offset shocks, and the economy became more susceptible to being destabilized by adverse developments. For example, if the government needs to rely on seigniorage to finance a temporary shortfall in taxes that amounts to 3 percent of GDP, this would have amounted to an approximate 20 percent increase in the monetary base in the early seventies, while in the eighties this would have represented an almost 100 percent expansion. The size of the shocks are dramatically
24 different, and the inflationary effects are likely to be much larger in the second case. Likewisce, shifts in private portfolios are also likely to be more destabilizing the smaller the size of the monetary base relative to domestic liquid assets. This problem is particularly acute in Brazil where the monetary base is just 2 percent of GDP while M4 is close to 30 percent of GDP. In this situation it is almost impossible foL the central bank to offset any changes in the demand for domestic assets through open market operations. In particular, a generalized run out of domestic assets will almost certainly result in a significant increase in domestic interest rates or else in a large increase in inflation.

# ii. Direct Oriains of the Recent Hvperinflations

A distinctive feature of the new hyperinflations was that they were not clearly driven by a single cause; there is no unique simple explanation that can rationalize each of them. This stands in contrast from the CH where the origins were very clear. Instead, they resulted from a combination of several domestic and external factors. In Argentina and Brazil, the hyperinflations were the culmination of a long process of deterioration in the fiscal accounts, increased fragility in the financial system, and a tendency to accept high inflation. As inflation became entrenched at higher plateaus it was more difficult to avoid a final explosion. Of course, the situation was complicated by limited access to external financing since the beginning of the debt crisis, weak monetary and fiscal control, and very limited availability of.non-inflationary domestic financing to the government. But each of these elements by themselves need not had caused a hyperinflation.
25 The story in Peru is somewhat different, because outright populist policies played a big role in starting.the hyperinflation. In this respect, the causes were clearer. Nevertheless, after the initial outbreak, the Peruvian hyperinflation and the ensuing stabilization process shared many common elements with those of Argentina and Brazil. In this respect, it does not look like a CH.

It is useful to take another quick look at the relationship between seigniorage and inflation in these three countries (this time using monthly data) before examining each of these experiences more closely. Figure 3 shows the monthly inflation and estimates of the revenue from money creation (or seigniorage) for the three countries.7 It is clear that in Peru, the beginning of the hyperinflation era was linked to excessive money creation in 1985 and 1986, which eventually led to an explosion in inflation starting in 1988. Lxkewise, the hyperinflation outburst of 1990 was oreceded by a large increase in seigniorage. This episode resembled the CH. In contrast, the relationship between seigniorage and inflation is less clear in Argentina and Brazil. In both cases, seigniorage appears to have increased in response to the beginning of the hyperinflation rather than the opposite as a result of an extreme Olivera-Tanzi effect. Inflation wa's pulling up seigniorage in the hyperinflations of 1989.

This evidence indicates that thg causes of the recent episodes are not as clear as in the classical cases. In what follows we will examine each experience in more detail and indicate in which respects the new episodes are different.

The revenue from money creation is calculated as the change in the money base divided by the price level.
Figure 3

# SEIGNIORAGE AND INFLATION

<!-- Start of picture text --> ARGENTINA<br>0.12 ._200<br>0.09 _140<br>0.06 .120<br>0.04 4-_ A - _8 0P-e<br>- I '~~~~~~~~~~~~~~~4<br>0.02. A..' S .6r 0<br>092<br>.qy~~~~~~~~~~-0<br>19os 1S86 1987 1988 1989 1990<br><!-- End of picture text --> <!-- Start of picture text --> BRAZIL<br>.90<br>270<br>.0<br>iSr._ I .50 _<br>-Xo 0, 7[ 7 s / .- 40<br>.0<br>20<br>O.,<br>198 1986 1987 1988 1989 1990<br><!-- End of picture text --> <!-- Start of picture text --> PERU nfiaton was<br>097- 120<br>go, . . ____; _<br>70 TO ~~~~~~~_.__ i ___ -100 -o<br>60 ._e<br>so ._ . _ _ r<br>40 ___ 3V~~~~~~~~3<br>.0<br>lo 0<br>19D8 1S80 1987 19W 1909 1990<br>-inflalin - ueagnivrn<br><!-- End of picture text -->
27

# a. Peru

The hyperinflation in Peru resulted from<sup>the over-expansionary domestic</sup> policies of Alan Garcia (annual data for Peru<sup>is presented in table 5.c). In</sup> August 1985, his administration launched a<sup>so called stabilization program</sup> aimed at reducing inflation which was mainly<sup>based on income policies, in the</sup> form of price and wage controls, and a fixed<sup>exchange rate. This was</sup> accompanied by expansionary monetary<sup>and fiscal policies. While monthly</sup> inflation initially fell from 10 to 3<sup>percent, the success was short lived,</sup> as could have been easily predicted. The<sup>government succeeded in preventing</sup> a full blown increase in inflation by<sup>keeping public sectors prices and the</sup> official exchange rate artificially low,<sup>and by financing the expansion in</sup> economic activity through losses in international<sup>reserves.</sup> In the end, however, the government ran out of reserves,<sup>and this triggered the beginning</sup> of a long hyperinflation.

One unique and intriguing feature<sup>of this hyperinflation was that, by</sup> and large inflation did not accelerate<sup>in an explosive manner, except at the</sup> very end. This stands in contrast with<sup>the CH, where once inflation reached</sup> hyperinflation levels it very quickly<sup>exploded (see figure 3.c). There was</sup> an extreme increase in inflation in<sup>September 1988 (when inflation exceeded</sup> 100 percent), but, to a large extent, this was equivalent<sup>to a once and for</sup> all increase in the price level in non-inflationary<sup>economies.</sup> Inflation then remained at the 40 percent per month<sup>step for around 7 months, and then</sup> fell to the 30 percent per month step for<sup>around a year. This ability to</sup> maintain relatively stable inflation at rates<sup>as high as 30 or 40 percent per</sup> month is unique to Peru, since the available<sup>evidence from high inflation</sup> economies indicates that inflations<sup>in excess of 20 percent per month are</sup> unstable and lead to hyperinflation<sup>(that was the case in Argentina and</sup> f-;'~~~~~~~~~~~~~~~~~~~~~~~~~
28 Brazil). This in itself is an indication that Peru is part of the high inflation economies and hence that its.hyperinflation has many features in common with those of Argentina and Brazil.

Figure 3.c shows that in Peru, this period of high but stable inflation was accompanied by decreasing seigniorage, thus suggesting that this was probably an important factor in explaining the limited control that the government was able to exert over inflation. This period is generally seen au one of tight money (e.g. Lago (1991)), hence indicating that tight money could be used to avoid an explosion in inflation even in situations where the fiscal position is out of control.

# b. Argentina and Brazil

The origins of the hyperinflations in Argentina and Brazil are somewhat different. We already argued that they were not directly generated by unusually large increases in seigniorage. Seigniorage levels, while high, were not out of line with historical levels.

In our view, the more immediate origin of the hyperinflations in these two countries was an increase in the instability of inflation in economies that already were facing very high rates of inflation. This instability developed as a result of stop and go policies towards inflation, in which most stabilization attempts were based on a large dose of income policies. The Austral plan in Argentina and the Cruzado plan in Brazil represent the beginning of this period of inflation-stabilization cycles.8 In the end, the recurrent failed stabilization attempts destabilized inflation in the longer term, and gave rise to similar hyperinflations in both countries.

8 These cycles are examined in more detail in Kiguel and Liviatan (1991).
29 Of course, failed stabilization attempts<sup>would not have resulted in</sup> hyperinflations if the economies<sup>were cot already experiencing high</sup> inflation. Likewise, high inflation<sup>could have been avoided by the adoption</sup> of policies to bring it down at an<sup>earlier stage. It was the combination of</sup> high inflation and the induced nominal<sup>instability, caused by unsound</sup> stabilization strategies, that created<sup>the conditions for inflation to</sup> explode.

The most relevant features of the period<sup>of the cycles in Argentina and</sup> Brazil can be readily noticed from figures<sup>3.a and 3.b. The 1985 Austral</sup> plan in Argentina represented a<sup>break with previous stabilization efforts as</sup> it was the first comprehensive stabilization<sup>program in many years. It was a</sup> heterodox program, as it combined<sup>orthodox elements --namely a reduction in</sup> the budget deficit and a fixed exchange<sup>rate-- with the heterodox component-</sup> -wage and price controls--. The<sup>initial success was later reversed, and as</sup> inflation started to picked up momentum,<sup>it was stopped through a new</sup> heterodox program (the first plan Primavera)<sup>with less emphasis on fiscal</sup> discipline and more on income policies.<sup>The failure of this program gave</sup> rise to new cycles, which were subsequently<sup>stopped by the February plan, the</sup> Austral II plan and the better known Plan<sup>Primavera. The failure of this</sup> last plan gave rise to a full blown<sup>hyperinflation.</sup> A similar pattern is apparent in Brazil,<sup>where the cycles started with</sup> another so called heterodox program:<sup>the Cruzado plan. As the Austral plan,</sup> it also relied on price and wage controls;<sup>unlike the Austral plan, it did</sup> not perform any adjustment on the fiscal<sup>side. In the end, however, this</sup> difference did not matter much,<sup>as inflation in Brazil evolved in a similar</sup> manner as in Argentina. The follow-up<sup>stabilization programs --the Bresser</sup>
30 Plan, **the Summer** plan, etc.-shared a *imllar stabLlzatlon **strategy,** and the ultimate outcoms **were** essentlally **the same.** The cycles set the stage for the outbreak of **the** hyperinflatlons. lA each _new_ cycle, inflation reached a new hlgher peak, whlle **the** perlods of low inflation that followed the implemntatlon of each stablilzatlon **attmpt** became shorter. The inflation-stabilizatLon cycles thus became shorter and more pronounced, eventually exploding lnto hyperinflation ln both **countries.** Hyperinflation was all but unavoLdable.

The outbreak of the hyperinflatlon in Argentlna coLncLded wlth the collapse of the Plan Pr$mavera. Accordlng to most **analyats (e.g. Machinsa** (1990)), the situation **was** complicated by **the** possibility that **the do stic** debt would be repudiated; a situation that led to a flight out of dmomstic assets. In Brazil, inflation probably accelerated ln anticipatLon of a new income policies based stabillzatlon program to be implemented by the Collor de Melo administration, and the possLblilty that **the** government would **also** repudiate its mushrooming domestLc debt (especLally **once** ArgentLna took those steps in December 1989).

In both cases, however, the specLfic clrcumstances that trlggered the beginning of the hyperinflatLon cannot be separated from the overall conditions prevailing at the time. The cycles were **explosLve, and it is** very llkely that hyperlnflation would have taken place **even** lf there were no expectations that the government would repudiate **lts domestic** debt. Anything short of a major stabillzation package capable of changlng lnflationary expectatLons ln a dramatlc way would have been insuffLicent to avoid hyperinflation.
31

# V. Programs to StoR Three Bia Inflations

# i. Basic Features of the Proarams

In the span of a year, Argentina, Brazil and Peru implemented major stabilization programs aimed at stopping hyperinflation. The launching of these programs coincided with the inauguration of a new administration in each country: July 1989 in Argentina under the Menem Administration, March 1990 in Brazil under the Collor de Mello administration, and August 1990 in Peru under the Fujimori administration.

The three stabilization programs represented a break from previous disinflation attempts. There was a clear shift with more emphasis on orthodox measures and only a limited use of income policies, which was done mainly to demonstrate a departure from previous stabilization strategies that were identified with failure. Balancing the budget on a cash basis became an explicit objective of the three programs, and Peru and Brazil were relatively successful in sticking with it. In addition, there was a clear shift in the choice of nominal anchor, relying more on money rather than on the exchange rate (the latter also being associated with failed stabilization attempts). In Peru and Brazil this was done from the outset, while Argentina shifted to a money based program later on (in December) after a failed attempt to stabilize the exchange rate. Finally, the programs were announced as comprehensive efforts also aimed at changing the long term prospects for growth, and for this purpose they included major structural reforms, mainly privatization of public sector enterprises and trade liberalization.

The comprehensiveness of these programs indicates that in all cases policy makers were seriously attempting to bring the economies back to a path
32 of contLnuous price stability. The thoroughness of the stabilization attempts and the adherence to flical dislciplne (especially in Peru) Lndicates that **the** basLi strategy was comparable to the one that succeeded ln stoppLng hyperinflatlon ln Bolivia.

The effectlveneos of these programs has been mlxed. True, they all succeeod in brlnging down lnflatlon quickly from the peaks of the hyperinflation to much lower levels. Nevertheless, inflation has been stubborn, in that the sense that it dld not fall to low or moderate levels (unlike the case of Bolivia where lt fell to around 20 percent per year). in Argentina, the inltlal attempt was followed by other deeper stabilizatLon programs, and **desplte** mixed results for a long time, inflatlon appears to be finally recedingt but thli took over two years. In Brazil the situation is more dlfficult, because after the failed stabilizatlon attempt inflatlon was again on the rise, lt then stabilized at around 20 percent per month, and the possiblILty of a new hyperinflation cannot be ruled out. Finally, Peru is still flghtLng to get LnflatLon down ln a sustalnable manner. Whlle the worse part of the hyperinflation ****see** to be over, the authorities are still fighting monthly rates of inflatlon which remaln stubborn at around 4 percent.

**We** will now diesuss the maln features of the programs and examine the reasons for **the** difficulties that these countries are facing in bringing down inflation ln a sustainable manner. In partLcular, we will argue that it is much more difficult to generate a change of regime after hyperinflation in the high Lnflation economies than it was in the CH.
33

# LL. Classic Stabilizaio

# rograms with Non-ClA

## a. Perus

The stabllization program in Peru l;wwned ln August 1990, **was** $Q59"nwd along the lines of the very effective BolLvian stabilization program, but did not achleve **the same degree** of **success. There was a clear** commitment to balanclng the budget, and for this purpose the government created a cash committee that would operate under **a strict** rule of keepiLg payments in lLne wlth revenues, slmilar to one that operated ln Bollvia. **The** committee in fact has abLded by thie rule, although some **arrears** mounted along the way. On the monetary **slde,** the program aimed **at** restraLLnng monetary growth, although there **were** no explieLt targets except for domestic credLt to the government. Whlle the program dld not **use** the exchange rate **as** the nominal anchor, on the contrary it allowed lt to float freely, the exchange rate was stabilized very quickly, as in the CH.

The fiscal adjustment was primarily effected by Lncreafsng **revenues,** which had all but collapsed during the hyperinflation. Government expenditures were already very low, and reduclng them further was not a realLstic possLbllity. The Lncrease in revenues **was** achloved by levyLng emergency taxes (on trade, real estate, etc.), elLmLnation of tax *xeVttlons and by drastically increasing public sector prLces **(e.g.** the prLie of gasollne was increased twenty-fold).

In addition, the government announced an ambltlous program of structural reforms wlth the lb-ective of reverslng the detrimental effects of wldespread government intervention. The forelgn exchange market was unified, bank deposLts denominated in dollars were authoriLzd, and the economiL **team** quickly started to work on reforming labor market legislation, de-regulatLon
34 and trade liberalization, tax reforms, rationalization of public sector expenditures and privatization of public seotor enterprises. This was accompanied by a determined effort to reinsert Peru in the world financial markets, reapproaching the multilateral organizations as well as the commercial banks.

This program was very ambitious, and its scope and depth clearly marked a break with the old regime of populism and widespread government intervention. It had many elements that showed a definite commitment to low inflation. In its design, the program did not look very different from the 1985 Bolivian stabilization effort. Both programs combined a commitment to stabilization with structural reforms. While it could be argued that the Peruvian program was fragile, the same could be said about the Bolivian one. A puzzling aspect of the Peruvian program was that stabilizing the exchange rate was niot enough to stabili-,e prices. Sachs (1986), in discussing the Bolivian experience, argues that in the short run stabilizing the exchange rate was enough to stabilize prices. This, however, was not the case in Peru. So why did Bolivia manage to stop inflation in its tracks while Peru could not?

Our interpretation is that these two countries differed in an important way: Bolivia did not have a tradition of high inflation, while Peru did. The hyperinflation in Bolivia was an unusual event, one that was perceived as clearly out of line with the low rates of inflation that Bolivia had in the past. Once hyperinflation came to an end the economy went back to the "normal" 20 percent annual rate of inflation. Peru, on the other hand, had traditionally been a high inflation country. The hyperinflation was the culmination of a long process in which inflation went up over the years. The hyperinflation was an extreme event, but the fact that it lasted as long as
35 lt did la an indication that the economy could functLon (though not very well) wlth extromoly hlgh **rates** of inflatLon (around 25 percent per month for over 2 years). The fLnal inflationary explosLon (over 300 percent ln just **one** month) was not enough to **ellminate** the porception that Peru was an *inflationary" economy. Inflation remalned alilve, though at much reduced **levels, mainly becauso** tho publi¢ had entrenched LnflatLonary expectations, which ln the ond became solf-fulfilling.

# b. **kaazLJ**

**Tho** Drazlilan stabilizatLon program of March 1990, the Collor Plan, **also** started along very orthodox lines and shared many elements with programs that stopped hyperlnflatlon. The program also included a comprehenaLve package of structural reforms cloarly indicating a chango of reglme. The maln objectLve was to reduce tho role of the state Ln the economy, and it included privatLzatLon of public sector enterprLsoe, trade liberalization and reforms Ln the labor market. On the fLscal slde, there was a flrm commltment to **eliminate the** budgot deficit, and to generate a surplus ln the primary and operational balances in 1990, an objective that was achlived. The available information indLcatoe that the prLmary surplus between April and December 1990 was around 2.5% of GDP. This wao a major achievement, given that the governmnt had been running dOficits in prevLous years.

Income polLcies played a secondary, temporary role only at the beglnning of the program. ThLs represented a clear departure from prevlous stabilization strategLes, whlch put more welght ln flghting the "Lnertial* forces of the inflation **procOes,** and essentially viowed **as** unnecessary any adjustment ln the fundamentals.
36 A central, though controversial, component of the program was a mandatory freeze of approximately 70 percent of the financial asseto for 18 months. While depositors lout access to their money during the freeze, the funds were supposed to earn indexation plus 6 percent per annum, with no servicing till September 1991. Until the freeze was enacted, most public's financial assets were in fact domestic government debt, with one day maturity and at a floating interest rate. The financlal system acted primarily as an LntermedLary for the government. The main purpose of the freeze was to improve the fiscal balance (by postponing payment on the service of domestLc debt) and to regain control over the monetary aggregates.9 As a result of the freeze liquidity fell from around 30 percent to just 9 percent of GDP. This drastic reduction in liquidity started to exert severe recessLonary pressures early on, prompting the authorities to implement a partial reversal of policies. As a result, by the end of April llquidity increased to around 15 percent of GDP. In spite of this reversal, money continued to be tight Ln the sense that monetary aggregates remained well below the levels where they were prior to the Collor Plan.

In contrast to the Argentine and Peruvian programs, the exchange rate continued to be managed as in the past. It was not used as the nominal anchor, in fact, most of the time the exchange rate had a passive role and simply accommodated inflation. Nevertheless, as in the other two programs the parallel exchange rate was stabilized.

As in the other recent experiences, despite a major stabilization effort inflation was not eliminated. On the contrary, after an initial fall from 81 percent in March 1990 to just 9 percent in May, inflation climbed 9 Zinni (1992) provides a more detailed description and analysis of the freeze.
37 back to 19 percent in December and has remained high since then.<sup>10</sup> The final effect of this program was thus not very different from previous ones that did much less in terms of fiscal and monetary adjustment. A frustrating outcome.

A new set of measures, the Collor II plan, was announced on January 31, 1991 to deal with the resurgence of inflation. One component of the new program was an attempt to deepen the fiscal adjustment, by dealing with the finances and the debt overhang of the state and local governments. **However,** this orthodox message was accompanied with the old practice of price and wage controls (which proved ineffective in the past), and attempts to new regulate financial markets, this time by eliminating overnight operations.

These mixed signals had a negative effect on the government's image. The initial attitude of the Collor administration of being tough and wilLing to pay the costs of disinflation, gave way to one where the authorities were concerned about reducing the costs of this process. In addition, the use of old failed policies also affected expectations in an adverse way, as they were associated with quick increases in inflation.

# c. Arantina

The Argentine stabilization program of July 1989, the Bunge & Born (83) plan, was the first stage of what has been a long term effort to stop hyperinflation. In contrast to the programs in Brazil and Peru, the 83 plan used the exchange rate as its nominal anchor, though as the others, it was solely based on orthodox measures and explicitly avoided the imposition of any type of controls on prices or wages. It also relied on a major fiscal 10 Monthly data disguises the fact that prices were fully stabilized for around 3 weeks early on.
A6 38 adjustment, and it announced major structural reforms. Among them was the privatization of the national telephone company (ENTEL) and the national airline (Aerolineas Argentinas).

The program evolved through a number of phases, ae new waves of increases in inflation forced the introduction of now measures to stabilize in a sustainable manner. The BB plan was followed by three stabilization efforts, each of them strengthening the prospects for price stability: the Plan Bonex, of December 1989 included a forced rescheduling of the domestic debt (similar to the one later implemented in Brazil), aimed at improving control on the money supply and reducing the budget deficit by severing the links between tight money and high interest rates. Liquidity was cut sharply, because short term time deposits were exchanged for long term bonds which were transacted in the secondary market at around 30 percent of their face value. The Plan Bonex also represented a change in the stabilization strategy, **as** the exchange rate was allowed to float and money took the role of nominal anchor. This harsh program failed to control inflation, and the government responded with a new stabilization effort in March 1990 (the **4,** Decree 435). This program essentially supplemented the previous one by deepening the fiscal adjustment (through cuts in subsidies and public employment as well am some revenue enhancing measures). Once again, there was a reversal on the inflation front with a brief acceleration in January and February 1991. In response to the latest reversal, a new economic team (led by minister Cavallo) announced a major stabilization effort, the convertibility or Autumn plan, the most recent and audacious effort to stop inflation. Not only was there a stronger effort on the fiscal side, especially through higher **revenues,** but the now economlc team went further and tied its own hends by adopting full currency convertibility at a fixed
39 exchange, and imposing strict limits on the amount of central bank financing to the non-financial public sector. Under the convertibility scheme, the central bank is required to hold enough international reserves to back the monetary base, while any devaluation will need to be approved by congress.11 The program is showing signs of success, as of November 1991 inflation was still falling, and converging to international levels, though there has been a slight setback in January 1992, as inflation reached 3%. While it is still too early to assess the sustainability of this program, it seem clear that the economy is much closer to securing price stability than it has been in the last four decades.

# iii. Why has Inflation been so Persistent?

Based on the findings of Sargent (1982) and Dornbusch and Fischer (1986) one would have predicted that given that the three countries were facing acute hyperinflations, and that the three of them launched orthodox stabilization programs which also included all the ingredients that could signal a change of regime (of the type suggested by Sargent), the ensuing outcome would have been price stabilLty. However, this did not happen. Neither was the case that stabilizing the exchange rate was enough to stabilize prices (as argued in Sachs (1986) for, his analysis of Bolivia). Argentina and Peru stabilized the exchange rate, but inflation continued at a higher pace.

Much of the existing literature (including Kiguel and Liviatan (1988)) argues that hyperinflations must come to an end because they represent an unsustainable process. Government revenues collapse, production comes to a 11 See Canavese (1992) for a more detailed analysis of the Convertibility program.
40 halt, and the whole economy starts to show strains that did not exist before. These costs were apparent in the three,new hyperinflations. Argentina and Peru experienced negative growth durlng the hyperinflatlons (as was the case ln Bollvla), whllo Brazil barely managed to grow. RegardLng government revenues, Peru **clearly** experLenced a collapse ln this respects as tax revenues fell to around 4 percent of GDP, whlle ArgentLna faced for the firat time a deterioration in public receLpts Ln the second quarter of 1989. A second reason that **makes** stabilization **easler** li the spread of dollarLzatLon, l.e. the **use** of the dollar **as** unit of account and store of **value.** Prices and wages **are** hlghly synchronLizd ln **these** cLrcumstances, and hence a sound orthodox program that succeeds ln stabilizLng tho exchange rate also succeeds in stabLliLing prLces. Hyperinflation is a bubble whleh can be brought down **very** quickly.

These arguments **are** largely true even for the new hyperLnflatLons. Inded, the hyperLnflatLons **were** brought to an end, **as** they proved to be excessively costly. This was done through the adoptlon of an orthodox stabilization program that also signalled a change ln regime, as was the case in the classic hyperLnflatLons. Though the exchange rate was stabilized this was not enough to stabilize prices.

TradltLonal wlidom thus faLled ln one respects once the bubble was brought down, the economies went back to "normal*. In countries that have a tradltion of hlgh inflation, normal does not mean price stablilty (as Ln Bolivia) but Lnstead inflation rates much above lnternatlonal levels. Where does thLs rate lie? It would be presumptuous to be precise about this "normal" rate, but lt must lie close to rates are considered to be sustainable and at which the economy was able functLon Ln the past. In Peru thli meant around 4-7 percent per month, in Argentina somewhere between 7-10
41 percent per month, and ln Brasli a rato that Le hlgher. The stabliLzatLon proc-se thus contlnues for a longer tle , and only wlth a drastic and pereLet-nt stabliLzatLon program will inflatlon eventually come down. The hyperinflatLon, however, can make the job of bringLng down lnflation easier than before, because the public went through this dreadful experLence and hence would be willlng to accept sacrlfices ln ordor to avoLd lts recurrence.

# lv. Was there a Chance of ReaLms?

Supporters of Sargent's vLew would argue that LnflatLon continued because the authoritLes dLd not manage to demonstrate that there had been a change of roegme. Thli argument is difficult to refute because the concept of change of regime le basieally subjectlve and country specific. Nevertheless, people famllLar wlth prevlous progrms aimed at stopping inflation ln these countrLes could easLly be convLnced that the new programs were a clear departure from the past; they were more daring and comprehensive.

An alternative, more plausible view is that in the hlgh inflation economies the change of regLme that is necessary to block hyperinflatLon is different from the one required to stablizL **prlces** Ln the long term. Indeed, it is relatively easy to bring down inflation from the heights of hyperinflation to "historical* levels. Once inflation stabilles- at somewhere between 5 and 10 percent per month, additLonal actions are requlred to show that a change of regime actually had **taken place.** The recent Argentine experience is useful to lllustrate thli fact. Figure 2 shows quite clearly the period of exploding cycles, that preceded the 85 plan, has been followed by another of convergLng **cycles.** The B3 plan was successful ln stopping hyperLnflation, though inflation contlnu-d at
42 around 5 percent per month. The initial program was clearly unsuccessful in showing that the new regime was one of.price stability. The failure of the initial attempt became apparent when a new inflationary explosion started in December 1989, prompted by a now run towards foreign currency as the government announced the plan Bonex. This now burst of hyperinflation was milder and ahorter than previous ones, and again it was brought down very quickly, this time through a program that succeeded in stabilizing the exchange rate (which was at the time flexible). Inflation, however continued at rates far above international levels (around 10 percent per month) for almost a year, and then it experienced a new increase inflation, which was even shorter and milder. Since then inflation has been receding, and recently has been hovering around 1.5% per month, a major achievement.

The new pattern of converging cycles has been induced by a continuous stabilization effort, where each set back (or rekindle of inflation) was fought with a new, more drastic program. The Bonex plan tried to provide a permanent solution to the domestic debt problem that had undermined so many stabilization efforts in the past. Likewise, the Decreto 435 stabilization attempt went much further on the fiscal side than any previous programs. The government was finally confronting the industrial promotion law which provided generous subsidies and open numerous tax loopholes without clearly incentivating industrial activitieu, and also announced important changes in tax administration and publlc sector reform. Likewise, the convertibility program went further than the others in imposing fiscal discipline, at the same time that undertook numerous wreal' measures to improve enforcement in tax payments.

During these two and a half years, in spite of changes in economic teams, the movement has been in just one direction: more fiscal adjustment,
43 through privatization of public sector enterprises, rationalization of public sector expenditures and better enforcement on tax collection (the latter has recently been accompanied by a simplification and rationalization of the tax system). Not once during these years **there** has **been** an important roversal in policies. In addition, unlike the period in which the cycles were becoming more explosive, the authorities have refrained from actively using price and wage controls as a way to bring down inflation, and have instead stressed the importance of getting the fundamentals in place.

The implementation of major structural reforms which unambiguously indicates that the economy is moving away from a model in which growth is based on import substitution with an active participation of the state was an important part of the change of regime. Privatization of public sector enterprises, elimination of subsidies to inefficient industries, elimination of restrictions to international trade and foreign investment are among the measures that have shown unambiguously that the country is relying on a market economy and clear rules of **the** game to lead growth. These measures complemented the stabilization efforts as they indicated that elimination of inflation was just one part of a much broader project. While inflation **was** not considered an obstacle for the previous model, it definitely is for an economy that is serious about restoring sustained growth.

Confidence in the program appears to have grown parL pasou with the government's commitment to the stabilization effort. Figure 5 shows the evolution of the ratio of market price to **the** par price of the Bonex (series 1982), a medium term government bond **denomanated** in dollars.n It can readily be noticed that the market price of **the** bonds collapsed during the hyperinflation. On the other hand, **there** has been a marked and continuous improvement since the BB plan onwards, and while there **were** a few "panics",
44 Figure 4

# INFLATION ARGENTINA

<!-- Start of picture text --> 200-<br>180 -- -<br>BB PLAN<br>160-<br>140- --<br>_-<br>120-<br>100---<br>ERMAN 11<br>80-_<br>60- .-..<br>_p 1._<br>40- USTRAL PRIMAVERA t l ------ l ICONVERT<br>201 1 1<br>t1985 1986 1987 1988 1989 1990 1991<br><!-- End of picture text -->
45 the Bonex is now quoting at their highest level in recent years. Thio can be interpreted as greater confidence on the fiscal situation, and on the government's ability to control inflation.

One lesson that comes out of the Argentine experience is that it is more difficult to demonstrate a change of regime in high inflation economies than it was in the CH. In contrast to the CH, the origins of high inflation is unusually not as clear, and the commitment to bring it down can not be shown as easily. In fact, it is likely to take a relatively long time, as was the case in Argentina. During that period inflation is likely to persist, and new hyperinflation outbursts might be unavoidable.

A second lesson that comes out from this experience is that there are strong complementarities between stabilization and structural reforms. The gains in this area twofold: first, they both contribute to a better allocation of resourcea, and second, and more important, doing them together sends a stronger signal regarding the direction in which the economy is moving.

The Argentine experience on the change of regime has useful lessons for Peru and Brazil, two countries that have not yet got to the point where v gentina is right now. In both countries inflation shows persistence. The trend, however, is different in each of them. The policy stance of the Peruvian authorities and the results achieved so far provide reason to expect that the program could produce good outcomes in the medium term. After tho initial reduction, there was an increase in inflation in December and January, but was relatively small and short lived (see figure l.c). On the other hand inflation fell to around 4 percent per month, but with no clear signs of receding. The policy stance adopted since the Fujimori administration took power has been supportive of a change of regime, but the
46 authorities have not yet succeeded in consolidating the fiscal position which remains very fragile (revenues are still low relatively to what is need to sustain an adequate level of government expenditure), while key structural reforms (namely privatizations) are just now being implementing.

In Brazil, on the other hand, there is not yet evidence that the explosive cycles of high inflation are moving one way or the other. In addition the policy signals are mixed. While the need for fiscal adjustment is widely acknowledge, and the government has been able to maintain a fiscal surplus, the privatization process has been slow and troubled by setbacks. At the same time, the authorities resorted one more time to price and wage controls ln the Collor II stabilizatLon program, an action identified with failed stabilization programs.

# VI. rnal Ramark

Much of the existing literature fails to recognize that high inflation (i.e. annual rates in three digits) L a distinct phenomenon from moderate and hyper-inflation.12 The failure to understand the specific features of the inflation process in the chronic high inflation economies has many times led to a wrong diagnosis of the underlying reasons for changes in inflation in these economies, and **the** policies that are needed to stabilize prices in these countries. These lack of full understanding extends to the interpretations of the recent hyperinflation in some of these economies.

Argentina, Brazil and Peru in the eighties are certainly part of the high inflation **economies. The** recent hyperinflations in these countries were not isolated **episodes** instead they **were** the culmination of an unstable 12 Kiguel and Liviatan (1988) discuss some of the especial features of these economLes.
47 Figure 5 <!-- Start of picture text --> Ratio of Bonex to Technical Value<br>and Inflation<br>6-<br>5 i<br>4 11<br>B X<br>-3<br>1987 1988 1989 go9<br>RATIO CPINFL .<br><!-- End of picture text -->
48 process, in which inflation crept up gradually for many years before accelerating into an explosive path. These episodes were important because they helped to dispel the myth that it is possible to maintain a stable high rate of inflation on a long term basis, without harmful effects on growth.<sup>13</sup> The causes of the new hyperinflations were not as clear as in the classical episodes, as they originated from a combination of fiscal and nonfiscal factors. The chronic fiscal imbalances eventually became an unsurmountable obstacle, and inflation moved away from the fragile high inflation equilibrium into hyperinflation. The interesting feature of the new episodes (especially in Argentina and Brazil) is that they were not triggered by a large increase in the budget deficit; instead, because the initial equilibrium was so fragile, inflation was in the end destabilized by financial shocks.

An important lesson of the new hyperinflations is that the process of restoring price stability has been longer and more costly than in the classical cases. The main reason for this outcome is that it is not clear ln the publics' minds where will inflation settle once_hyperinflation is stopped. In the CH expectations were that inflation would return to the low levels that prevailed before. In contrast, in the new episodes there is no compelling reason for agents to expect that the economy would go back to low inflation. Experienced showed that inflationary expectations initially settled near to the level where inflation was. prior to the hyperinflation. As a result, the disinflation process must continue once hyperinflation is stopped.

13 This view was especially strong among Brazilian economists, who used the experience of the late seventies to argue that high inflation is not an obstacle to growth. These arguments proved wrong in the eighties, when inflation went out of control and growth collapsed.
49

# Befin es

- Beckerman, Paul (1991). "Public Sector.Debt Distress in Argentina's Recent Stabilization Efforts," mimeo, The World Bank.

- Cagan, Phillip (1956). "The Monetary Dynamics of Hyperinflation," in studLea in the Quantity Theory of Money, Milton Friedman editor, Chicago: University of Chicago Press, pp.25-117.

- Calvo, Gullermo and Carlos Vegh (1991). "Credibility and the Dynamics of Stabilization Policy: A Basic Framework," mimeo, International Monetary Fund.

- Canavese, Alfredo (1992). "Hyperinflation and Convertibility Based Stabilization in Argentina," mimeo, Instituto Di Tella.

- Dornbusch, Rudiger (1976). "Expectations and Exchange Rate Dynamics," JourZal of Political Economy, Vol.84 pp. 1161-76.

- Dornbusch, R. and S. Fischer. (1986). "Stopping Hyperinflation Past and Present", Weltwirstchaftliches Archiv, Vol. 122, January.

- Garber, Peter M. (1982) "Transition from Inflation to Price Stability," in Carnecie Rocheoter Conference Series on Public Policy, 16. pp.11-42.

- Kharas, Homi and Brian Pinto (1987). "Exchange Rate Rules, Black Market Premia, and Fiscal Deficits: The Bolivian Hyperinflation," Review of Econo..ic-Studiee.

- Kiguel, Miguel A. and Nissan Liviatan. (1988). "Inflationary Rigidities and Orthodox Stabilization Policies: Lessons From Latin America," _Tha. .N2Kld_ Bank Economic Review, Vol. 2, No.3, September, pp.273-298.

- (1991). "The Inflation Stabilization

- Cycles in Argentina and Brazil," in Lesson of Economic Stabilizatioa and its Aftermath, M. Bruno, S. Fischer, E. Helpman and N. Liviatan Editors, Cambridge, MA: MIT Press.

- (1992). "The Business Cycle Associated

- with Exchange Rate Based Stabilization," The World Bank Economic Review, May.

- Lago, Ricardo (1991). "The Illusion of Pursuing Redistribution Through Macropolicies: Peru's Heterodox Experience (1985-1990). in The Macroeconomics of Populism in Latin Amercia, R. Dornbusch and S. Edwards Editors, Chicago, University of Chicago Press.

- Machinea, Jos Luie. (1990). "Stabilization Under the Alfonsin Government: A Frustrated Attempt," mimeo, The World Bank.

- Morales, Juan Antonio, (1988). "Inflation and Stabilization in Bolivia," in Inflation Stabilization. M. Bruno, Di Tella, Dornbusch and Fischer editors, Cambridge, MA: MIT Press, pp. 307-46.

- Rodriguez, Carlo. A. (1981) "La Estrategia de Estabilizaci6n con Tipo de Cambio Flexible y Politica Monetaria Activa," EMA, Serie de Documentos de Trabajo No. 82.

- Sachs, Jeffrey D. (1986). "The Bolivian Hyperinflation and Stabilization", NBER Discussion Paper No. 2073.
so

- Sargent, Thomas J. (1982). "The End of Four Big Inflation," in .nglatignJ. caus-z and Effect., " R. S. Hall (ed.), Chicago: University of Chicago Press..

- Webb, Steven (1986). "Fiscal News and Inflationary Expectations in Germany After World War I," Journal of Economic History, Vol. 46, No.3 pp. 76994.

- Wicker, Elmus (1986). "Terminatus Hyperinflation in the Dismembered Habsburg Nonarchy," American Economic Review, 76, pp. 350-64.

- Sini Junior, Alvaro A. (1992). "Monetary Reform, State Interventions and the Collor Plan," mfimeo, University of Sao Paulo, Brazil.
# MONTHLY INFLATION

<!-- Start of picture text --> ' '<br>il__ ~~~~~~~~~~~~~~~~~~~..' . '.' ' '. . . . .'..._.-. '. .<br>0.01 n.a 34.13 nA n.6 t 10.53<br>0.08 ne 1.16 n. n 0.08 MO<br>0.04 n.6 410 ne ne 004 051<br>0.0a n.a 442 ne ne 006 OJ0<br>0.06 nA -. 61 na n. 0.06 3.57<br>0.07 na .0.72 nA n.e 0.07 1084<br>0.06 na 5.64 ne n.e 0.06 2.00<br>0.00 ne 345n.e n. 0.00 17.60<br>0.10 n. -2.0 nOA nAe 0.10 11 70<br>0.11 n.a 2.72 n. n 0.11 24.76<br>0.12 n.a n4.64 n.e na 0.12 25.10<br>121 0.01 n. 0.00 n. n. I"4 0.01 0.76<br>0o2 41.00 -4.17 ne o 0.02 22.76<br>0.06 13.48 -2o ". 8.3 21.5<br>0.04 .4.02 .0.75 n. 586 0.04<br>0.06 4.31 -1o n 20S 005 702<br>0.06 23.07 4S0 n 848 0.06 4.00<br>0oo -4.07 4.8 n. 0.00 0.07 6.25<br>0.0a 16.78 84.27 2"? 1631 0.06 14.06<br>0.0o 20.74 7.61 16.4 13.8 0.00 37.30<br>0.10 i | | 11 | || 10^64 00 a66 0.10 I1_<br>o.11 30A2 . 2.06 -10.01 o.11 31.62<br>0.12 a.0.0 2.0 -2.62 0.12<br>1922 0.01 21.23 6.10 .1.82 8.3 89" 160.01<br>0.02 26.04 11.72 44 7.11 0.02<br>0.03 Z.03 3244 10.47 170 .3<br>0.04 11.12 0.13 6a O2m 0.04 11.76<br>0.05 25.26 1.7 2.3 4.70AQ0 0J.O7<br>0.00 0.62 17.2 11.62 006<br>0O. 4101. 44.52 34& 1.07<br>0.06 MAOo 8We 0.06<br>0.00 Q ° 24.50 1221 0.Q0<br>Q.10 7.6.66 80.16 1 ^a<br>0A11 .04.7.1 86" 0.11 8.20<br>0.12 -1.64 2.18 2.3 2566 0.12 160O<br>1025 o.Oi 0.67 I1& 60.01 32.0<br>0.02 1.65 0.02 705<br>0.06 1.0@ -10s4 lo 0.06 0.07<br>0.04 6.72 0.68 16.2 7.12 Q04 8.0<br>0.066 Us _2__ _ __ .27 0.06 O7<br>0.00 e 0.06 4.20<br>0.07 *6.44 '.00 1.78<br>0.06 -C42 _ 0.06 0.64<br>0.0 10.20 [ i ', -' §.78 02 o0.0o 2.20<br>0.10 0.10 069<br>0.11 0.11 .0.11<br>0.12 t. -,A4 0.12 0.66<br>1024 0.01 -7.t7 47l 1.00 0.01 2.46<br>0.02 0.03 0.00 1.72 4.6 0.46 _ 12.O -1.27 0.02 0.03 0.70 1.23<br>0.04 0.11 3.33 .70 -1.21 0.4 1.59<br>0.05 1.67 .1.61 0.2 n. 0.06 0.4<br>0.0 1.06 4.02 -172 n.e 0.06 4.12<br>0o. na 4.66 aoo n 0.07 4.CS<br>0.06 n. 48 -U2 n. 0.00 OA<br>0.00 n.A G 4.n. 0.00 o0<br>0.10 n.a S.1 2.17 n. 0.10 2OO<br>0.11 n.e .16 1.00 n. 0.11 40.20<br>0.12 n.M 1.65 1.61 n.A 0.12 O.O<br><!-- End of picture text -->
# **MONTHLY INFLATION**

|MOS|1559|18.58|8.51|
|---|---|---|---|
|mo8|18.08|20.33|8.86|
|M02|25.64<br>|20.87|30.88|
|M03<br>|27.56<br>|21.74<br>|21.71|
|M05|11.68|25.16||
|M1o|9.03|26.53|40.60|
|Ml1|5.73|27.70|24.40|
|M12|6.83|28.23|41.87|
|1989MO0<br>|8.93<br>|39.07<br>|47.34<br>|
|M02|9.56|13.10|42.49|
|M03|17.00|5.79|41.99|
|M04|33.40|5.36|48.63|
|MOS||13.26|28.61|
|MOe||28.00|23.05|
|M07||33.87|24.58|
|Moe|37.86|33.39|25.06|
|M09|9.36|34.08|26.86|
|M1O|5.60|38.65|23.25|
|MU|6.52|45.48|25.84|
|M12<br>|,00733.75|||
|1990 MOI|||29.73|
|M02|||30.59|
|M03|||32.63|
|M04|11.37|17.24|37.39|
|M05|13.61|9.63|32.80|
|Moo|13.90|12.75|42.52|
|M07|10.83|14.71||
|Moe|15.34|1||
|M09|15.68<br>|13.12<br>|13.77<br>|
|Mi1|7.69|14.04|9.61|
|M1|6.18|16.74|5.93|
|M12|4.68|1887|23.73|
|1991MO0|7.70|19.91|17.83|
|M02|26.99|21.53|9.42|
|Mo0|11.04|6.60|7.70|
|M04|5.51|8.61|5.84|
|MOO|2.80|7.05|7.64|
|MoO|3.12|11.72|9.26|
|M07|2.59|13.31|9.06|
|Mo8|1.30|15.49|7.24|
|M09|1.77|16.87|5.56|
|mIO|1.35|23.98|3.95|
|_IlU1_|n.a|25.36|3.96|
|1012|n.a|23.79|3.74|
# Policy Research Working Paper Series

|**Title**|Author|Date|Contact<br>for paper|
|---|---|---|---|
|WPS977 Income Security for Old Age:<br>Conceptual Background and Major|Estelle James|September 1992|D. Evans<br>37489|
|WPS978 How Restricting Carbon Dioxide<br>and Methane Emissions Would Affec<br>the Indian Economy|Charles R. Blitzer<br>t R. S. Eckaus<br>Supriya Lahiri<br>Alexander Meeraus|September 1992|WDR Office<br>31393|
|WPS979 Economic Growth and the<br>Environment|Dennis Anderson|September 1992|WDR Office<br>31393|
|WPS980 The Environment: A Now Challenge<br>forGATT|Piritta Sorsa|September 1992|WDR Office<br>31393|
|WPS981 After Socialism and Dirigisme:<br>Which Way?|Andres Solimano|September 1992|S. Fallon<br>37947|
|WPS982 Microeconomics of Transformation<br>in Poland: A Survey of State<br>Enterprise Responses|Brian Pinto<br>Marek Belka<br>Stefan Krajewski|September 1992|S. Husain<br>37139|
|WPS983 Legal Reform for Hungary's Private<br>Sector|Cheryl W. Gray<br>Rebecca J. Hanson<br>Michael Heller|October 1992|R. Martin<br>39065|
|WPS984 Barriers to Portfolio Investments<br>in Emerging Stock Markets|Asli Demirg0i;-Kunt<br>Harry Huizinga<br>b|October 1992|W. Patrawimolpon<br>37664|
|WPS985 Regional Integration, Old and<br>New|Jaime de Melo<br>Claudio Montenegro<br>Arvind Panagariya|October 1992|D. Ballantyne<br>37947|
|WPS986 The Administration<br>of Road User<br>Taxes In Developing Countries|Roy Bahl|October 1992|J. Francis-O'Connor<br>35205|
|WPS987 How the Epidemiological Transition<br>Affects Heafth Policy Issues in<br>Three Latin American Countries|Jose Luis Bobadilla<br>Cristina de A. Possas|October 1992|0. Nadora<br>31091|
|WPS988 Ewonomic Valuation and the<br>Natural World|David Pearce|October 1992|WDR Office<br>31393|
|WPS989 The Indian Trade Regime|M. Ataman Aksoy|October 1992|R. Matenda<br>35055|
|WPS990 Protection and Industrial Structure<br>in India|M. Ataman Aksoy<br>Francois M. Ettori|October 1992|R. Matenda<br>35055|
|WPS991 Environmental Costs of Natural<br>Resource Commodities: Magnitude<br>and Incidence|Margaret E. Slade|October 1992|WDR Office<br>31393|
# Policy Research Working Paper **Series**

|**Title**|Author|Date|Contact<br>for paper|
|---|---|---|---|
|WPS992 Regional Integration<br>in Sub-Sahara<br>Africa: Experience<br>and Prospects|n Faezeh Foroutan|October 1992|**S.**Fallon<br>37947|
|WPS993 An Economic<br>Analysis of Capital<br>Flight from Nigeria|S. Ibi AJayi|October 1992|0. Miranda<br>34877|
|WPS994 Textiles and Apparel in NAFTA:<br>A Case of Constrained<br>Liberalizatio|Geoffrey Bannister<br>n Patrick Low|October 1992|A. Daruwala<br>33713|
|WPS995 Recent Experience<br>with Commercia<br>Bank Debt Reduction|l Stijn Claessens<br>Ishac Diwan<br>Eduardo Fernandez-Ari|October 1992<br>as|Rose Vo<br>33722|
|WPS996 Strategic Management<br>of Populatio<br>Programs|n Michael H. Bernhart|October 1992|**0.**Nadora<br>31091|
|WPS997**How**Financial Uberalizatio**n**<br>i<br>Indonesia Affected Firms' Capital<br>Structure and Investment<br>Decisions|John R. Harris<br>Fabio Schiantarelil<br>Miranda G. Siregar|October 1992|W. Pitayatonakarn<br>37664|
|WPS998 What Determines<br>Demand for Freigh<br>Transport?|t Esra Bennathan<br>Julie Fraser<br>LouisS. Thompson|October 1992|B. Gregory<br>33744|
|WPS999 Stopping Three Big Inflations<br>|Miguel A. Kiguel|October 1992|R. Luz|
|(Argentina,<br>Brazil, and Peru)|VissanLiviatan||34303|