Lessons from the heterodox stabilization programs

Abstract

This paper draws lessons from the advantages and disadvantages of the heterodox stabilization approach in chronic high inflation countries. Heterodox stabilization programs make temporary use of some income policies - price and wage controls - to support orthodox policies. Heterodox programs were successfully tried in two chronic high inflation countries, Israel and Mexico. In both cases these programs were followed by a second, more orthodox stage and included the use of the exchange rate as the nominal anchor. While the programs succeeded, both experienced costs in the form of an appreciation of the real exchange rate and high real interest rates. The main lessons from the experiences as analyzed by the authors are : 1) the initial, rapid reduction in inflation at the beginning of heterodox programs is the easy part; the difficult part is to maintain price stability over time; 2) income policies in heterodox stabilization programs are only justified in high chronic inflation countries (with annual rates of inflation above 100 percent) where inflationary persistence is more pervasive and problematic; 3) there is a case for a larger fiscal adjustment in heterodox programs because of the risk that a government that starts with price controls could be confused with one that tries to achieve price stability without adjusting; and 4) a heterodox program that fails is likely to lead to a large amount of inflation instability.Economic Theory&Research,Environmental Economics&Policies,Economic Stabilization,Insurance&Risk Mitigation,Insurance Law