World Development, Vol. 19, No. 8, pp. 969-986, 1991. 0305-750X/91 $3.00 + 0.

00
Printed in Great Britain. Pergamon Press plc

Inflation in Argentina: Stop and go since the

Austral plan

M I G U E L A. KIGUEL*
The World Bank, Washington, DC

Summary. - - This paper examines the Argentine experience with inflation and stabilization
attempts between 1985 (the time of the launching of the Austral plan) and late 1988. The Austral
plan was a heterodox program in the sense that it initially combined orthodox components - - s u c h as
a tightening in fiscal and monetary policy - - with less orthodox ones such as wage and price
controls. While the design of the Austral program was sophisticated, the inability to deal with the
structural fiscal problem made this effort futile. In addition, the repeated use of price and wage
controls in follow-up stabilization attempts was a mistake as it led to greater inflation variability,
as it induced additional price and wage increases in anticipation of a new round of controls.

1. I N T R O D U C T I O N of the exchange rate was p r e a n n o u n c e d in h o p e s

High inflation has b e c o m e a chronic feature of
the A r g e n t i n e e c o n o m y . It has only w o r s e n e d
over the years as inflation rates have crept up to
increasingly higher levels. Inflation has survived
the i m p l e m e n t a t i o n of several serious a n d com-
p r e h e n s i v e stabilization p r o g r a m s , and the use of
alternative stabilization strategies. T h e Austral
plan was the most recent of these attempts.
T h e r e were t h r e e m a j o r stabilization efforts
prior to the Austral plan. T h e 1959 stabilization
p r o g r a m u n d e r Frondizi was l a u n c h e d along
strict o r t h o d o x lines. It was b a s e d on m o n e t a r y
a n d fiscal discipline, and a s h a r p d e v a l u a t i o n of
the e x c h a n g e rate. T h e p r o g r a m succeeded in
bringing d o w n inflation quickly (from 113% in
1959 to 14% in 1961), but it was not able to
m a i n t a i n it at the reduced levels for a significant
period. A n alternative a p p r o a c h was followed in
1967 u n d e r Krieger V a s e n a . This p r o g r a m com-
b i n e d the a d j u s t m e n t in f u n d a m e n t a l s (namely a
r e d u c t i o n in the fiscal deficit) with an income
policies package. It was also successful in the
short run, a n d achieved price stability for almost
t h r e e years, but inflation came back and even
surpassed p r e v i o u s levels in the early 1970s.
A f t e r a short-lived populist stabilization p r o g r a m
during the P e r o n i s t g o v e r n m e n t , a third m a j o r
a t t e m p t was l a u n c h e d u n d e r M a r t i n e z de Hoz.
T h a t p r o g r a m started along o r t h o d o x lines (with
some use of i n c o m e policies), but its limited
success in r e d u c i n g inflation p r o m p t e d a shift in
strategy with the e x c h a n g e rate playing a central
role as a stabilization i n s t r u m e n t . T h e future path
that this would be an effective a n c h o r to influ-
ence e x p e c t a t i o n s a n d bring d o w n inflation. T h e
policy was effective in bringing down inflation
( t e m p o r a r i l y ) at the cost of an o v e r v a l u a t i o n of
the currency a n d severe external i m b a l a n c e s . T h e
p r o g r a m collapsed in 1981, a n d inflation m o v e d
to an even higher level.
Despite the dissimilarities in the design of
these p r o g r a m s , most of t h e m were able to strike
transitory gains in the fight against inflation. T h e
ultimate o u t c o m e s , h o w e v e r , were disappoint-
ingly similar. T h e p r o g r a m s were eventually
a b a n d o n e d as a result of a d e t e r i o r a t i o n in the
fiscal situation a n d in the balance of p a y m e n t s .
Inflation r e t u r n e d invigorated, reaching even
higher levels.~ A s can be seen in Figure 1 t h e r e
has b e e n a close relationship b e t w e e n deficits
( m e a s u r e d as a p e r c e n t a g e of G D P ) and inflation
o v e r the years, as well as a c o n t i n u o u s inability to
bring down the b u d g e t deficit on a p e r m a n e n t
basis. T h e fiscal cycles are an i m p o r t a n t feature
of the A r g e n t i n e e c o n o m y ; they have b e c o m e a
b u r d e n that any new stabilization p r o g r a m will
have to address.
*The views expressed in this paper are my own, and
should not be attributed to the World Bank and its
affiliated institutions. This paper is part of the research
project, Stopping High Inflation, supported by the
World Bank. I greatly benefited from lengthy discus-
sions with Ernesto Feldman and Nissan Liviatan and
from comments by Juan Carlos de Pablo, Bill Easterly,
Federico Sturzenegger, Enrique Szewach, Steve Webb
and two anonymous referees. Jariya Charoenwattana
provided valuable research assistance.

969
970 WORLD DEVELOPMENT
2O
15
I~Deficit
l lnflation ~
1965 1970
n i~_ _ ~ - - - -. _ ~ _ , . . _ r - ~ , , ~ . . . . . . . . . .
Figure 1. Argentina: Fiscal deficit and in)lation.
The inflationary developments following the
Martinez de Hoz era were complicated by the
dramatic and continuous deterioration in internal
and external economic conditions. The govern-
ment budget deficit got out of control during the
last years of the military g o v e r n m e n t , exceeding
by some estimates 20'7,, of G D P , and remained
basically the same during the first two years of
the Alfonsin administration. On the external
side, the situation deteriorated as a result of high
interest rates, and a continuous fall in the terms
of trade. Decreasing availability of external
credit following the beginning of the debt crisis
made matters worse as the authorities were
forced to finance deficits ahnost entirely through
domestic sources. This is reflected by the large
seigniorage levels (around 8% of G D P ) that were
prevalent during 1982-84. 2
These massive, money-financed budget deficits
were the major force behind the relentless
acceleration in inflation from 100% in 1981 to
over 1,800% during the second quarter of 1985.
The situation was unsustainable and, in the
absence of drastic measures, the economy was on
its way to hyperinflation.
The Austral plan, launched in June 1985, was a
response to this crisis. It was a stabilization
program whose main objective was to pull down
inflation very quickly to manageable levels.
Although the stated purpose was more ambi-
tious, to restore price stability and eradicate
inflation from the economy, the g o v e r n m e n t
never undertook the necessary measures to
accomplish this goal. The Austral plan was a
heterodox program in the sense that it combined
orthodox components, namely tight fiscal policy
and m o n e t a r y restraint, with the less conventio-
nal instruments of price and wage controls. A
new currency was introduced, the austral; there
700
600
. / \'t
500
),\ Jitt
400 .~
300 _c
/ / ] /'--/ !' I I
2O0
100
....~-',,.#
/
1975 1980
/
1985
i 0
was an initial devaluation followed by an ex-
change rate freeze; and the effects of the
unexpected reduction in inflation were neutral-
ized through a novel mechanism based on the
introduction of a conversion table for existing
contracts (the desagio).
The program was initially very successful in
stopping inflation. Inflation fell from 30% in
June 1985 to 3.1% in August, when measured in
terms of consumer prices, while the reductions
were even more impressive in terms of wholesale
prices (see Table 1). Unfortunately, as most
stabilization efforts in Argentina, the Austral
plan also failed. After one year of relatively low
inflation, there was a continuous increase in
i n f a t i o n which by the end of 1988 reached pre-
austral levels.
The behavior of inflation has become erratic
since the failure of the Austral plan. Inflation did
not immediately exceed prestabilization levels,
but it became more volatile than it did following
other failed stabilization programs. As can be
noted in Figure 2, the economy underwent
conspicuous inflation-stabilization cycles in
which the accelerations in inflation were not
always related to increased fiscal imbalances. In
addition, the country was on the verge of
hyperinflation on three occasions during this
period (see Figure 2) although the deficit and
seigniorage did not return to pre-austral levels in
all cases.
This paper examines the behavior of inflation
and other relevant macroeconomic w~riables
since the beginning of the Austral plan. It
provides a more comprehensive evaluation of the
program than in the existing literature since it
analyzes, within a unified framework, the various
subsequent programs that were introduced dur-
ing the Austral era by the economic team that
 INFLATION IN ARGENTINA
designed the original plan. In this respect, the
paper provides a broader perspective of the
period. Section 2 discusses the strategy of the
original program and raises policy and analytical
issues regarding its implementation. Section 3
traces the evolution of the program with particu-
lar emphasis on the inflation-stabilization cycles
and the inflationary outbursts. Section 4 conclu-
des with a discussion of some of the policy les-
sons from the Argentine experience regarding
the implementation of the so-called heterodox
shocks.
2. STRATEGY AND IMPLEMENTATION
OF THE A U S T R A L PLAN
(a) Strategy
The Austral plan was a heterodox program
which combined orthodox elements, such as
fiscal discipline and monetary restraint, with
price and wage controls. The basic strategy,
discussed in more detail in de Pablo (1987),
Canavese and di Tella (1988), Frenkel and
Fanelli (1987), Heyman (1987), and Machinea
and Fanelli (1988) among others, attempted to
provide a comprehensive response to the large
existing imbalances in public finances and to the
inertial elements of the inflationary process.
Orthodox measures, while necessary for success,
are not sufficient to bring about a rapid disinfla-
tion process in chronic high inflation countries,
such as Argentina, where inertial forces are at
work. Inflation inertia can result from staggered
nominal contracts, backward indexation of
wages, or lack of credibility regarding the sus-
tainability of government disinflation policies. A
freeze on wages, prices, and the exchange rate
was seen as the appropriate instrument to deal
with this problem.
The short-run success of the program de-
pended heavily on the government's ability to
find rapid ways of reducing the large budget
deficit and to engineer an effective strategy for
dealing with the behavior of nominal variables.
Its long-run success required a permanent reduc-
tion in the budget deficit to a level consistent with
the target of low inflation and the choice of a
nominal anchor to make this objective feasible.
There is wide agreement among analysts about
the soundness of the initial strategy, and on its
great effectiveness for bringing down inflation
quickly without large costs. Indeed, the initial
policy measures as well as the overall results
during this stage share many common elements
with the more successful Israeli stabilization
program of July 1985. 3 There is less consensus on
what led to the resurgence of inflation during
971
1986; most analysts (e.g., Broda, 1987; Rodri-
guez, 1988) attribute it to the reappearance of
important fiscal imbalances, while others point to
problems of managing nominal variables, parti-
cularly wages, in a closed economy with imper-
fect competition (e.g., Frenkel and Fanelli, 1987;
Canavese and di Tella, 1988).
In the remainder of this section we will analyze
the main components of the stabilization prog-
ram, address potential weaknesses in the original
design, and the initial results.
(b) Implementation
The analysis will focus on four aspects of the
program: fiscal policy; management of prices,
wages and the exchange rate; monetary policy;
and monetary reform and desagio.
(i) Fiscal policy
At the beginning of the program the author-
ities accomplished a significant adjustment in the
fiscal accounts. Although there are well-known
difficulties in measuring the deficit in Argentina,
it is clear that there was an initial drastic
reduction in the total budget deficit which,
according to official sources, was cut from 11.7%
of GDP in the first quarter of 1985, to 2.3% in
the third quarter (Table 2).* A closer analysis,
however, indicates that most of this reduction
was of a transitory nature and was likely to
evaporate very quickly if inflation resurfaced.
Government expenditure was basically un-
affected by the program, although some adjust-
ments had been made in the months preceding
the plan. Reductions in real wages in the public
sector and in public investment were made prior
to the Austral plan, particularly during the
second half of 1984 and the first months of 1985.
Changes in tax revenues were the major force
behind the improvement in the fiscal accounts.
The four main elements were an increase in trade
taxes, higher public sector prices, the introduc-
tion of a forced savings scheme (essentially a
disguised tax), and improvements in tax collec-
tion resulting from the reduction in inflation. Of
these, only trade taxes could be expected to
increase revenues on a permanent basis,
although they were also the most detrimental to
an efficient allocation of resources. The introduc-
tion of trade taxes created an additional anti-
export bias at a time when the country was facing
very serious problems in its external sector.
The realignment of public sector prices was
largely attained prior to the Austral plan. This
adjustment was reinforced on June 14th when the
authorities increased public sector prices by
23.6%. As a result of these measures, relative
 Table 1 Arqetltl~ul l]a~u itllti~ate~lt, ]9NS~gN
©
l n d i c e ~, ol R e a l W a g e Ileal 7Z
t"
Public Nominal Exchange Rate I)¢xaluation Public Nominal R a t i o ol Ratio of
('P| WPI Utility Wage M1 M4 Real Wag,: Industrial Construction Lltilit,. Deposit Rediscount R e , . e n u c to Nonagricultural
77
Inflation Inllation Price Change (Jrowth (;rowlh ()fficial l'arallcl Premium per Hour See:or Sector Price lntcrcsl Rate Expenditure W P I to C P I 77
(I)* (2)* (3) (4) (51 (~) (71 (S) (91; (IH); (11 },~ ( 121,," (13t (14)i [ (12,) (I6)¶ (171
<

19b,5 g""
Jan 25.1 212 193 21t5 I t) 0 191-; 2511 32.S 1!14 l{)Ofl l i b I~ n a Hill {I 249 20 5 67fl l[)(I.II
©
Feb 2(I.7 17.8 15.5 154 t33 194 2116 32 ~ 311 I-; g>7 9b, I-, n a 95 7 209 20.5 5'5,~ 98 3
Mar 265 27.7 25.6 21.4 15.7 18 l 26 4 27 U 31 5 91 £ 977 n.a 95 l 23 5 203 46(I I00 7
i:
Apr 292, 31 5 26.1 24 9 199 2711 294 311U ~ $8~ 97I~ II.a ~2t~ 274 215 40.0 11131 Z
Ma~ 25 I ~1 2 40fl 31.7 172 25 '5 32.5 17 4 178 93 3 1112.2 t)gS 1113.7 31. I 325 57.9 109.4
Jun 3H.5 423 487 287 54.7 ~61~ 4(I.2 288 S3 92 II Ufl I tllfl IIX I 16.,"; 185 33.3 1190
Jul '52 -119 69 -27 47 1 28 2 87 bS2 17.7 S42 S7 I~ $8¢n 1189 ",2 (~ () S7.9 1095
Aug ~ 1 15 (LO (13 5 I g.2 Ill} I 0 189 SI.9 83.5 SOIl 1153 57 17 9 111119 1(1(~.4
Sop 2.l) I}.(~ ill) 1.3 6.11 85 O.fl -13 17 ~ Sl 4 S5.2 ,~4: 1131 5.3 7 ¢, 1023 11144
Oct I 9 (1.7 t(.(I 1.1 1((.I( S.q tl0 l.h IS.4 Nt) 7 9113 N26 111(9 43 5.0 ll)7 '5 1(13fl
Nov 2 4 I) 7 0.0 2~ 10 4 77 fill 2 9 121 807 N¢~ ~ Sll S 1(183 44 2`11 126.4 lOll.b;
Dec 3.2 Ill 1) tl 46 II2 ?'6 110 4N ()b, El v Sq7 7N ~ l(}q II 44 ,1t t139 98.2
19N~
JaR 3(I ().ll (t(( 54 SS 72 I111 3.2 12 ~ X~7 $9~ SO.3 1ill.9 44 2`.0 91~ 93 4
Feb 17 ()8 fl.O 2 I O(J 6~ 0[) 43 75 84 {I Sg I 7U 0 IH(12 4.'~ ~, 0 787 g42
Mar 4'5 t 4 04 [t I; II 5 2` S Oil ~'.6 134 Sfl.3 854 77, f~ 962 4.9 f~ 6 1~55 91.2
Apt 4.7 3 0 64 7.2 42 5 4 33 1.4 114 82.2 S8.8 ";3 I t)7 7 4 4 ,5.3 92 1 897
May 4.o 2.7 3 t) 2`.1~ 8.6 6x 2 fi 2 4 I~.0 83.4 987 Sfl2 97 fl 4 4 ~ll 112,9 S82
Jun 4.5 46 411 42 7() 62 2,', I) e, 25 S3. ] gS,~ $211 g7. l 43 ~ 1 09.2 S7.S
Jul 6.8 5 I 711 7.4 ",4 68 34 2 2 12 81 7 983 947 973 4h '54 U2tl 87 I}
Aug 88 94 fl.() 9 {1 13 47 h.Y. Igg 124 X~ S 9'53 874 ggN {~.5 7I~ 1117 N ST, U
Sop 72 68 4 I IS 1'5 42 (-, S 12~ 164 792` 93 2` N25 92(I l~.t; t) 3 71 .S S4~
Oct ~ I 5 3 42 1111 28 7 1 4 i 211 U6 S32 qS~, 89 ,'~ t~(14 7 g III I Oil tl S34
No', 5.3 4 9 48 4.7 7.3 911 52 12 '5 177 S2S S9.~ ,q5 3 90 II 7 7 I{! ~ 71 i ,",37
Dec 47 3(I 58 2 "~ ll.N 74 q4 159 2t)(I '~1 II S7.g X47 Ul II S 3 Iris ~,4 ] S4 I
19X7
Jail 7'5
Feb ,55 69 '59 37 -117 5H 7H -ill 2~N 7~.1 SSl 7X4 ~tl ~ 75 ]111 70fl ,~2:)
Mar 8.2 7.8 7.11 2.11 5.9 4.4 114 9.8 220 74.5 82.5 74.5 893 4,0 1/.3 836 82.0
Apr 3.4 1.9 0.0 8.5 7.4 4.5 0.0 8.5 32.3 78.2 8~6 72.1 86.4 71 8.3 676 80.9
May 4.2 4.9 4.0 3.9 5.1 59 3.2 1.3 29.9 781 96.4 737 86.3 77 9.0 87.8 80.9
Jun 8.(l 6.7 g.7 7.2 6.¢~ 8.2 73 11.5 217 77.4 911.1 85.4 868 8.3 96 70. l g0.2
Jul 10.1 9.4 10.0 6.0 8.2 7.5 ll.(~ 14.8 25.9 74.5 879 75.8 86.8 11t6 l().9 88.5 79.7
Aug 137 14.6 12.2 11.3 -11.2 6.5 11.7 22.7 38.4 73.tl 85.1 72.4 85.,5 123 13.8 78.8 79.9
Scp 11.7 16.0 9.1 [6.4 3 3 8.1 16.2 17.9 411.5 76.11 91.3 79.8 836 15.4 164 76.4 83.5
Oct 19.5 30.5 34.2 18.7 8.4 10.11 32.0 14.6 22.11 75.5 88.9 75.5 93.9 12.4 141 79.6 92.4
Nov 11).3 4.3 8.4 6.'-) 11.4 11.3 8.2 28 15.9 73.2 81.6 68.7 92.3 8.9 11.2 65./} 87.8
Dec 3.4 2.3 0.11 7.1 18.3 [0.2 U7 12.4 29.3 75.8 83.4 ~9.4 893 12.3 141 63.6 86.6
1988
Jan 9.1 12.1 6.4 .ma. 6.7 11.1 9.3 19.3 41.1 n.a. 83.6 74.8 87.0 13.2 16.7 55.4 88.3
Fcb 10.4 13.4 10.7 n.a. 1.2 9.6 12.1 ~.11 33.3 na. 79.3 695 92.11 133 15.6 58.5 91.2
Mar 14.7 16.3 18.5 n.a. 6.0 14.5 12.2 9.5 30.2 n.a. 80.1 70.4 95.0 15.7 180 65.9 93.1
Apr 17.2 16.8 22.5 n.a 11.9 13.11 18.2 9.4 2(1.(~ n.a. 78.3 60.9 99.3 16.2 187 78.6 93.3
May 15.7 23.3 28.2 n.a. 11.1 14.9 17.3 125 15.7 n.a. 86.2 n.a II0.1 17.2 19.5 88.8 100.3
Jun 18.t) 24.11 15.9 n.a. 17.5 17.5 19.8 31.4 26.9 n.a. 82.2 n.a. 108.2 19.5 21.9 79.9 1114.1
Jul 25.6 25.11 24.8 n.a. 19.2 19.7 19.6 18.9 26.1 n.a. 77.2 n.a 107.4 22.7 24.7 74.1 103.2
Aug 27.6 31.9 31.7 n.a. 17.6 261 24.3 159 17.6 n.a. 76.8 n.a 110.8 IU.6 13.5 83.4 106.6
Sep 11.7 6.4 2.3 n.a. 16. I 21/.6 11.0 1.4 19.3 n.a. 80.8 n.a, 101).6 9 1 11 7 70.7 1110.3
Oct 9.0 4.6 3.7 n.a. 14.4 11.3 1.9 4.5 22.3 n.a. 82.6 n.a. 95.8 9.3 I I .g 67.11 95.7
Nov 5.7 3.9 5.9 n.a. 8.5 1114 3.7 30 21.5 n.a. 87.1 n.a ')5.9 10.2 12.5 1112.9 95.0
Dec 6.8 5.7 4.3 n.a. 26.8 16.2 36 2.2 19.9 r,.a. 86.6 n.a 93.7 12.2 14.7 71.3 94.1
1989
Jan 8.9 6.9 6.0 n.a. 10.0 16.0 4.1 6.8 23.11 n.a. 86.2 n.a. 91.1 12.1 14.5 91.0 92.0 t"
Fch 9.~ 8.4 7.4 n.a. 7.9 8.7 6./) 494 73.4 ha. 81 6 n.a 89.3 189 206 611+2 91/.2 >
Mar 17.0 18.9 8.9 n.a. 8.4 12.1 5.6 612 1647 n.a. 85 5 n.a 831 21.7 24.8 64./I 89.9
Apr 33.4 58.0 19.8 n.a. 15.1 220 234.2 58.6 25.6 r~.a 70.7 n.a. 74.e, 445 411.2 382 1031
May 78.5 11M..5 5911 n.a. 50.7 43.8 143.6 99.2 2.7 ha. 884 na. 66.5 1278 103.2 31.8 115.2 7"
Jun 114.5 132.3 62.5 n.a. 107.2 114.7 68.9 213.9 909 ha. 7111 n.a. 51~4 135.1 1431 113.8 128.1

Sources: lndicadores de Coyuntura (various issues). Columns (5), (6) and (14) from ('arm Econonuca (various issues) >
*Inflation rates and interest rates are monthly rates.
~Premium is the excess of parallel exchange rate over official exchange rate ( % )
~Real wage per hour is calculated from nominal hour wage deflated by CPI. m
§Industrial wage index 11983 - 100), Construction wage index (19811 - 100). 7'
)llntercst rate on 30 day deposit was regulated trom J a m - M a r . 1985. ,...1
¶Revenues of the central government as a percentage of expenditures.
>
974
6°f
50
~ 40
. W P l inflation
E
.~_
20
=:
E lo ,1
~- 0
10 i , , i , , i . . . .
1985 1986
Source: Carta Economica (various issues) and Indicadores
de Coyuntura (various issues).
Figurc 2. Argentina: WPI inJlation am/ deposit rate.
public sector prices reached their highest real
value in the 1980s (see Table 1). This favorable
situation could not last beyond the first few
months because public sector prices were part of
the nominal anchors the authorities were using to
control the general price level. If inflation were
to continue, as it in fact did, the initial cushion in
relative prices would be lost, weakening the
budgetary position of thc public sector enter-
prises.
The forced savings scheme was designed as a
one-time compulsory loan from individuals and
corporations to the government. In principle this
was not a tax, since the govcrnment had to repay
the loan. Nevertheless, it was considered at that
time as genuine income for the purpose of
calculating the budget deficit. In practice, it did
work as a tax, because the g o v e r n m e n t borrowed
at a very low nominal interest rate which became
negative with the increases in inflation in later
years.
The final element contributing to the increase
in tax revenues was a gain in efficiency in tax
collection which, paradoxically, resulted from
the reduction in inflation. Because most taxes are
paid with a lag, an increase in the rate of inflation
erodes the real value of government revenues
(this is the well-known Olivera-Tanzi effect). A
drastic reduction in the rate of inflation works in
reverse, increasing the real value of tax revenues.
Thus, the initial success of the Austral plan on
the inflation side provided an important support
for the consolidation of the fiscal situation.
(ii) Prices, wages and exchange rate policies
The m a n a g e m e n t of nominal wmables was a
WORLD DEVELOPMENT
t..L.I" ,'1
I . . . . . . . . . . . t . . . . . . . . . . . I . . . . i . . . . . . I,, ,
1987 1988 1989
central part of the program. A freeze of prices,
wages and the exchange rate was introduced to
deal with the inertial aspects of the inflationary
process. The authorities realigned relative prices
at the outset ill an attempt to minimize distor-
lions during the freeze and to provide a cushion
in public sector prices and the real exchange rate.
The duration of the freeze was not made explicit,
but it was clear that this was a transitory rncasurc
and that efforts would be made to aw~id clear
distortions in relative prices which coukt have a
detrimental impact on the allocation of re-
sources.
The realignlnent-freeze approach was scnsible
and very similar to the more succcssftfl Israeli
S
p r o g r a m . Nevertheless, the strategy has impor-
tant limitations which are relevant for the evalua-
tion of further developments and the interpreta-
tion of the later resurgence of inflation. The
authorities cannot realistically expect to hit the
equilibrium vector of relative prices at the time of
the freeze. At best, they can attempt to awfid
clear imbahmces of key government-controlled
prices (i.e., the exchange rate, and public sector
prices and wages). In this respect, past informa-
tion, though useful, might not be very relevant.
Equilibrium relative prices change over time m
response to new developments in the domestic
and international markets, and these changes are
likely to be very drastic as the economy moves
from high to low inflation/' A sccond difficulty
arises because the government cannot realign
every price m the economy. This is particularly
clear for private sector prices where the approach
was to freeze prices according to the levels
prevailing at a given date (June 13th in the case
of the Austral plan), without any realignments.
 INFLATION IN ARGENTINA 975

Table 2. Nonfinancial public sector: Exlwnditures', revenues, deficits, and seig,niorage (cash basis, percet ~ge of (;I)PI

Operational Primary Dcficit of the Total Alternative

Expenditures Revenues t)eficit Deficit Central Bank Deficit Budget Deficit Seignioragc
(1 y (2)i- I3) 14) (5)': (6)§ (7) (8)11

1984 31/.6 22.6 8.1) 3.1 2.7 10.7 12.1

[ 31. I 22. I 9.1 4.3 5.6 14.6 9.2 8.7
11 32.5 22.9 9.~ 4.1 (~.0 15.~ 2 I2 8.3
I II 27.7 21.9 5.8 1.4 3. I 8.9 8.8 7.4
IV 31.7 24.0 7.7 2.5 2.3 1(I,[) 10.0 7.8
1985 311.4 26, 1 4.3 1.5 2.4 6.7 11.4
1 28,8 21.5 7.3 1.4 4.4 11.7 12.11 6,4
II 28,7 21.8 6.9 11.9 5.11 I1.9 23.7 9.9
Ill 29,3 27.~ 1.7 ~.6 1.2 _. ? 5,M 8.9
IV 34,7 33.3 1.4 4,8 0.t~ 2.3 3.9 7.3
1986 28.4 26.4 2.11 - 1,9 1.9 3.9 5.4
1 , 9 . ,"~ 27.0 ~"
_._ I .9 1.7 3.9 4.3 2.1
II 28,4 27.8 0.6 4.1 1.3 1.9 3.6 5.2
111 26.9 26.9 0.0 2.7 .~ ~ . . ~. ~ . . .6 . 8 . ~ 8'
IX,,' 29.2 24.1 5. l 11.9 2. I 7.2 ~).7 5.4
1987 ~t
_~._-~ 24.1 5.1 1.3 11.9 6.11 7.7
[ . 7 . "~ . . . . "4 ~
"~ _~,.0 11.1 1.8 4.8 ~.6 2.4
11 31.3 .7~ q . . 5.8
. . I .:~' 1.7 7.5 7.4 4.1
Ill 29. I 25.2 3.9 0.7 1.4 5.2 7.8 1.9
IX," 29.5 21.9 7.6 3.2 1.2 6.4 111.6 (~.5
1988¶ 23.11 18.7 4.3 0.4 I.t~ 5.9 S.H
I 24.3 18.11 6.3 2.11 _.N~' 9. I 9.8 _.~3
~
11 22.7 19.3 3.4 1.3 1.3 4.7 8.0 5.5
Ill _0.3
" - 18.4 2.1 11.2 I~ 2.(~ 6.0 6.4:''
IV _4._ 19.0 ¢,.2 I.[1 2.11 7.2 8.0 6.~':'

Sources: Ministry of Economy; Colunrn (5) 1984.1 -1987.4 from Central Bank ol Argentina; 1988 from the World 13ank: ('ohnnn
(7) from Fundacion Meditcrranea (January-March 1989): Column (8) fiom ('arm Econonlica (various issues).
~Column (1) includes national and provincial govcrnmcnts, social sccurit? systcm and deficits ol public cnterpriscs.
•"Column (2) excludes current revenue of public enterprises.
:~:Column (5) Central Bank estimation.
§Column (6) - Cohmm (3) + Column (5).
[[Column (8) - MI(t)-MI(t-I)/GDP(t).
¶is pteliminary and excludes provincial government.
• *Estimated

Due to staggering of nominal contracts, however, A different approach was adopted for wages, a
the economy will have a "disequilibrium" struc- t h i r d a n c h o r t o t h e s y s t e m . I n i t i a l r e s t r a i n t in
t u r e o f r e l a t i v e p r i c e s a t a n y p o i n t in t i m e . I n n o m i n a l w a g e i n c r e a s e s r e s u l t e d in a r e d u c t i o n in
A r g e n t i n a , a s w e l l a s in I s r a e l , t h e e x t e n t o f t h i s real wages, especially m the public sector, s which
problem was somewhat reduced because there was important to support the fiscal effort and
w a s a s i g n i f i c a n t a c c e l e r a t i o n in i n f l a t i o n p r i o r t o restrain demand. Wages however, were the first
the program, which reduced the duration of variable to be "flexibilized'" and their role as
nominal contracts hence increasing the synchro- anchor was probably weaker because private
nization of price decisions] sector wages continued to grow during the
The freeze-realignment approach implicitly freeze.
acknowledged that inflation would persist, T h e f i n a l a n c h o r w a s i n d u s t r i a l p r i c e s '~ w h i c h
though at a lower level. There was an initial were subjected to direct controls. The freeze was
overshooting of the exchange rate (which was effective at the wholesale level (rather than at the
devalued by 15% over and above the large retail level), a feature that explains the dissimi-
devaluations prior to the program) and public larities in behavior between the consumer price
sector prices. This overadjustment was necessary index (CPI) and the wholesale price index (WPI)
to support the freeze of these variables for a during the early period.
r e a s o n a b l e s p a n in t h e p r e s e n c e o f i n f l a t i o n . In In summary, the exchange rate and public
the absence of these measures, the country would sector prices were the main nominal anchors of
h a v e f a c e d a s e v e r e o v e r v a l u a t i o n o f its c u r r e n c y the system, and they were supported by price and
as well as a deterioration in the fiscal accounts. w a g e c o n t r o l s . T h e i n i t i a l r e a l i g n m e n t in r e l a t i v e
976 WORLD DEVEIA)PMEN'I
prices, by providing a cushion t o the two m a i n
i/nchors, increased the likelihood of stlecess of
tile strategy.
(iii) Mo,etarv pelt 0'
The m a n a g e m e n t of illOllctiiry policy and
interest rates during the early stages of a stabili-
zation p r o g r a m is a very delicate and difficult
matter. Tile p r o b l e m is especially complicated m
those progranls that arc successful and achiew_" a
rapid reduction in inflation. Interest rates have
been slow to r e s p o n d to the changes it] inflation
in most p r o g r a m s , leading to a drastic increase in
rcal interest rates. Two main reasons havc been
p r o v i d e d to cxphiin this d o w n w a r d rigidity in
nominal interest rates: first, it could result frolll
the adoption of a very restrictive m()lletaly policy
by tile central b{lllk, alld secoild, it could be ti~c
effeci of lack of credibility regilrdhlg the suslaillil-
bilitv of noiniila] variables.
Tile discussion can be clarified with the help e l
the f o l l o w i n g set of equations:
m M/I' (1)
i = r + ~" (2)
m - L(r + st") 1.' <- () (3)
E q u a t i o n (1) is the definition ol real II]OllC~
balances, w h e r e M is the m o n e y supply and I' is
the price level. Equation (2) states that the
nominal intet-est rate (i) is equal to thc real
interest rate (r) plus the expected rate of inflation
(~"). Finally, equation (3) states the c q u i l i b r i u m
conditions for the money market. This equation
implies that thcrc is an reverse relationship
between real money holdings and the nominal
interest rate. IH
As long as the money market remains in
e q u i l i b r i u m low (high) real moncv bahmces will
be associated with high ( l o w ) nominal interest
rates. EmPirically, however, it is diflieult to
establish w h e t h e r interest rates remain high
because n]oncy is tight, or if instead real money
balances stay at low levels becausc the equilib-
rium n o m i n a l interest rate contitlttes to be high.
T h o s e who c o n s i d e r that in]crest rates arc high
due to tight m o n e y (e.g., D o r n l m s c h , 1986),
implicitly assume that inflation expectations react
quickly to new d e v e l o p m e n t s ( ~ falls a h n o s t
i m m e d i a t e l y after the i m p l e m e n t a t i o n of the
stabilization p r o g r a m ) . Tight m o n e t a r y policy is
responsible for the stickiness in n o m i n a l interest
rates.
If prices were fully flexihle m both directions,
an increase (a r e d u c t i o n ) in real m o n e y balances
could be effected t h r o u g h a reduction (an in-
crease) in the price level. In such a world, tight
money w o u k t not be ill] obstacle to :l lall in
interest rates. This is not. however, a rclcxanl
case since m general there is d o w n w a r d inflcxilfil
itv of prices. Ncvertheless, there are in practice
various mechanisms that could al[o',~ ~ll] illCl¢ilsc
in the 1111rl0%% lllOl]etal-\r. a..ic.atLs.,-~,
" '~, • : \ g e n t s c o u l d
ad,just their domestic portfolios and increase the
stock of M1 relative to other financial assets. In
addition, portfolios could b c a d ustcd through
international financial flows. If interest rates arc
high. there v. ou[d be capital inflows increasing
the supply of domestic assets.
Thc alternative explanation assumes that there
is stickiness m infliltionarv expectations (e.g.,
Sachs, 198fl). Individuals do lit)! believe that the
program is ~oin~ to last ( ~ ' rcmains high),
hencc, according to equation (2), interest ratcs
also remain high. lA~\v teHl IllOllC\ I~alances arc
the resuh of high intercsl rates. To the extent
thai the rate tfl inflation (~) tails, ~ + +7< and
c.t-po~l real intercst rides \~ill be high. According
to this vie~k, h ( ) \ v c k e r . ('A-(IIII(' ICil[ il/tClCb| rHte%
itlO II()l I]CCCssilIiIV high.
/\ mistake in the diagnosis e l the causes of high
interest rates will be costS' flu the e e o n o m \ . 11
the go\,eFllnlellt w r o n g l } thinks that interest rates
arc high as :t result e l tight m o n e \ and tries to
deal with this p r o b l e m b \ increasing domestic
credit, it ~ill creutu an excess SLlppl~ of nlone\
and u l t i m a t e l \ destabilize the m l t i - i n l l a t i o n pro-
tess. If, on the othcr hand, it errs by using tight
IllOI1eV and IIcllCC allowing real interest r',ttcs to
remain high, it \\'ill introduce additional reccs-
sit)llal+ prcssuleS and l+Ossibl} worsen the fiscal
aCCOUI]tS.
gince an accurate diagm)sis is it] practice \'or\
difficult, the govcrt+n]Cllt has to choose which
alternative is less risky givcn its own priorities. If
its main goal is to succeed m Iwinging do\~n
inflation, then it is safer to err on the side of high
real interest rates that] on the side of cxccss
d e m a l l d pleggLlles ill t h e goods market. In C()tlt]-
lt'iug such its A r g e n t i n a , it short period of high
real interest rates is a price ,aorth paying it it can
ensure Imx infhltion it] the longer term,
The a\'ailahlc evidence indicates that the
Argentine authorities followed a prudent
a p p r o a c h at tile outset of tile progran]. T h e r e was
a large increase ill domestic credit (and in the
m o n e y supply) prior to thc p r o g r a m and during
its first weeks, which contributed to the sharp
reduction in mot]thly nominal interest rates from
30 to 6% (scc Table 1). The initial monetary
expansiOll p r i m a r i l y a c c o m m o d a t e d the increase
in money demand resulting from tile reduction in
tile o p p o r t u n i t y cost of holding money in a low
inflation e n v i r o n m e n t . Despite its size. the cx-
plttlSiOll tlid llOt creatc' atl excess s u p p l y of i11orlev
 INFLATION IN ARGENTINA
as illustrated by the capital inflows that entered
the country during the first two weeks of the
program (estimated at U$3l)0 million).lt In fact,
a policy of easy money would have led to capital
outflows. The overall evidence indicates that the
government followed a reasonable monetary
policy during the very early stages of the pro-
gram. As will be discussed later, however,
monetary policy remained sound only for a very
short time span.
Money did not play a central role its a nominal
anchor in the program. Even in the early stages,
in spite of the high ex-post real interest rates,
most analysts consider that monetary policy was
primarily accommodating. " Although there
were a few instances in which the authorities
followed a policy of tight money, they were
relatively short lived and were abandoned once it
was apparent that the consequence was a hmg
period of high real interest rates.
(iv) Monetary r<[brm and desagio
Two interrelated elements of the program
were the monetary reform, and the desagio, an
ingenious scale of conversion aimed at minimiz-
ing the transfers between borrowers and lenders
that would result from an unanticipated sharp
reduction in the rate of inflation.
The monetary reform consisted of the intro-
duction of a new currency, the austral. One
austral was equivalent to 1,000 units of the old
currency (the peso). Monetary reforms of this
type had been carried out twice before (in 1970
and 1983), and in both cases they only meant a
change in numeraire and had no effects on
inflation or expectations.
The monetary reform based on the introduc-
tion of the austral differed in two ways from
previous efforts. First, the new currency, was
introduced as part of a comprehensive stabiliza-
tion package. Although the austral was fiat
money and was not backed by any real assets, its
introduction was accompanied by an announce-
nrent that no additional money would be printed
to finance the budget deficit. This promise, if
fulfilled, was especially important since there was
a wide (and well-founded) perception at the time
that central bank financing of the deficit was at
the core of the inflationary process. Second, and
more important, the new currency was necessary
on legal grounds to make the desagio possible•13
A rapid and unanticipated reduction in infla-
tion will, in general, redistribute incomes (and
wealth) from debtors to creditors. At time when
inflation is high, nominal interest rates also tend
to be high in order to maintain a constant real
interest rate. In high inflation economies,
changes in nominal interest rates are primarily
977
determined by changes in the expected rate of
inflation. When the Austral plan was launched,
inflation and interest rates were close to 30% per
month. These interest rates were largely a reflec-
tion of the assumption that inflation would
remain at those levels in the near future•
The sharp disinflation accomplished by the
Austral phm was an unforeseen event for lenders
and borrowers. Nominal interest rates contracted
prior to the plan would have resulted in extra-
ordinarily high ex-post real interest r~,tes (close to
20% per month}. To avoid these effects the
government introduced a mechanism (the de-
sagio) that converted the value of financial
agreements originating prior to June 14 with
maturities after that date according to a predeter-
mined rule• This was implemented through the
introduction of a scale of conversion from pesos
into australes for those financial obligations
maturing after June 14. This mechanism was
particularly important for the public sector (in-
cluding the central bank) which was a net
debtor.la It is conceivable that in the absence of
the desagio the budget deficit could have been
one or two percentage points higher than it
actually was during the first months of the
program.
(c) Initial results
By and large, the Austral plan was a well-
designed program to combat inflation. It showed
an appropriate balance between the orthodox
and heterodox measures that are necessary to
stabilize quickly while avoiding large reductions
in economic activity. The main potential prob-
lems for the success of the plan were on the fiscal
side, where the adjustment, although significant,
was largely based on short-term measures and
hence was extremely fragile, and on the viability
of the exchange rate freeze given the limited
access to foreign borrowing as a result of the debt
crisis. Program sustainability required that the
authorities would introduce very quickly a major
fiscal reform aimed at improving government
revenues on a permanent basis, and that they
could maintain inflation at low levels in order to
avoid overvaluation of the currency.
The initial results were very impressive but
similar to other heterodox programs. ,5 Inflation
fell from 348% per semester in the first half of
the year to 20.2% in the second half. The
adoption of price controls was very important for
the sharp disinflation, although their exact role in
the stabilization effort remains unclear. The
government did not introduce additional enforce-
ment mechanisms to check compliance with price
regulations, so the reduction in inflation was
978 WORLD DEVELOPMENT

mainlyKKKJKKJJJJJJHHHHHIIUIUBYGFFDFDDSSSG T
p r i w t t e s e c t o r , in a d d i t i o m the c o n t r o l s did not
p r o d u c e e x c e s s d e m a n d s a n d h e n c e s h o r t a g e s in l i k e l y ;.it M u c h l o w e r levels. As c:.iil be n o t i c e d in
m o s t m a r k e t s . T h e initial s u c c e s s w a s e n h a n c e d
by an i m p r o v e m e n t d u r i n g the third q u a r t e r m
the c u r r e n t a c c o u n t of the b a h m c e o f p a y m e n t s .
a n d only a slight r e d u c t i o n in the level o f
e c o n o m i c activity (see T a b l e 3).
D e s p i t e the a u r a o f s u c c e s s s o m e w a r n i n g signs A l t h o u g h parl of this c x p a n s i o n w a s certainly
s t a r t e d to d e v e l o p in the f o u r t h q u a r t e r . W h i l e
i n f l a t i o n r e m a i n e d at relatively l o w Icvels (at
2 . 5 % p e r m o n t h ) , the c u r r e n t a c c o u n t t u r n e d
into deficit a n d the e c o n o m y m o v e d very quickly
into an e x p a n s i o n a r y cycle, m a i n l y p r o p e l l c d by a
c o n s u m p t i o n b o o m ( T a b l e 3). T h e s e e v e n t s w e r e
t r o u b l i n g since an i n c r e a s e in d e m a n d can
w e a k e n the a n t i - i n f l a t i o n e f f o r t while the de-
t e r i o r a t i o n in the b a h m c e o f p a y m e n t s w a s likely
to r e d u c e t h e ability to m a i n t a i n the fixed
e x c h a n g e r a t e , h e n c e l e s s e n i n g the credibility of
the p r o g r a m .
h e to
clue ev{}lution a r y "n o m
- v o l u n t of i n a l ~arhiblcs
con~pliance by the m a d c ii
clear t h a i i n f l a t i o n was g o i n g to stay. l h o u g h ~ e r \
Table 1, m o n e y s u p p l y c o n t i n u e d g r o w i n g
through{}ut the year. A f t e r the initial large
i n c r e a s e to satisfy thc i n c r e a s e in the d c n l a n d for
m o n e y , M 1 a n d M4 e x p a n d e d r e s p e c t i v e l y f~4 a n d
5{1% b e t w c c n A u g u s t alld D e c c m b c r of 1085.
a b s o r b e d by i n c r e a s e s in the d e n l a n d for n l o n e v .
its size was i l l e o l n p a t i b ] c w i t h all oi~lec~iw of
zero i n f l a t i o n alld it t i n d e r i l l i i l c d the c r e d i b i l i t y of
thc p r o g r a m , it,
In a d d i t i o n , thc persistence of i n f l a t i o n , t_'vei1
at the m u e h l o w e r Icvels, alld the ;~,,:.lge i n c r e a s e s
g r a n t e d by the p r i v a t e s e c t o r and public e n t e r p r i -
ses c r e a t e d p r o b l e m s for the s u s t a i n a b i t i t v o f {tie
freeze on the c x c h a n g e ratc a n d prices oi public
s e c t o r e n t e r p r i s e s . T h e initial c u s h i o n w a s slowly
being e r o d e d and it was I~cconling incrcasingl 5
a p p a r e n t t h a i there was a need {o change the

Table 3. /IrTcllli,,la: NaliomU ac('(Hlllls aml Ih(' I,alalH~' o[ ]IatlHCIH,s

Nalional ;leeOtllils [~ill;lllt'c tll pLlylllelilS

industrial ( "tlllc'll I liadc Financial' l~.¢sei~¢
(}l)P ('OllsUlllp|il)ll [llVI2StlIR'lll plodtlcliOll {itcl}l.llll billalRe sl_'l;iO_'s i.]ltillg~_'s [Cl[US tll l l a d c
(millions {+1 atlstralc's. 1970 I'riccsl {Inillions el 1.1S$1

1984
11,185.3 8.~51.{~ 928.2 1.959.f~ 107.1~ 1,2U4AI 1.351.4 672.f~ 104.'~
II IIX}12.t 8.524.5 1.3UI U 2,3h3 7 137.~ 1.351111 1,448.2 297.8 {)1.,s
111 I 1,581.5 8,832.7 1,22f~.1} 2,388.4 749.f, 755.11 1,471.6 488. ~ 91. I
IV 12.316.5 0.426.11 I .nSl A, 2.299.5 1.311¢~ 8 124.11 1.441} S 217.3 112, 1
1985
11.19~. I 8.6111.4 1,llf~f~.I 1.893.> 77q.8 826.0 1.441. I 2,<-;8.3 121 8
[I 1{U127.4 7.758.1 1.12[.f~ 2.{159.3 181}.9 I .{}43.0 1.428.2, 821.{* 11174
Ill 111.368.8 7.(W~.3 843.2 1.933.0 100.9 1.331.(t 1.221.6 ,43f~.(~ II I1}. f/
IV 11.6511.1 %138.2 1.151.2 2.104.7 4608 782.11 1.214.l) :,2.1.2 un.8
l {)N6
11.182.9 M.f~44.il 1,136.7 1.992.1 -8(13.0 >92.0 1.147.11 435.11 11123
II I 1,693.7 8,~23.2 1.284.5 2,274A> 456.0 £14.1} l.lt}6.0 .441.3 85.O
III 1 1.756.5 M,926.3 1,1}8f~.3 2.446.11 -3118.11 54! .{1 t}34.11 380.{} S6.f~
IV 12.368.4 %618.8 1.3¢¢) 4 2,4118.11 1.0cJ2.l} 17011 1,139.{1 .03S.II 82.~
1987
11,627.5 9.1711,4 111478 2.047.1 I,l127AI 241,11 1.{142.tl 461,ll $8.2
II 12.024,5 8.t'~311.7 1,tsM¢).8 2.383.7 -8{itJ.li 3f~2.1} 1.157JI 1.3f~8.0 838
III 11,857.3 8,<":,67.8 1,442.11 2.373.0 1,11f~.ll 17.0 I,II44,11 1,2211.11 8:~.7
IV 12.M4.0 9.47t5.2 1,544.7 2.2~2.U 1.333.1} 311.11 1,242.11 214.11 NIA
1988
I 1,8{}4.3 9,177.2 1.168.{} 2J}54.5 -~52.lI >48.0 1,]16.0 739.0 NiA
II 11.925.1 8.191.8 1,813, 1 2,253.3 427.0 897.0 1.344.0 43l}.0 N/A
III 11.21(~.3 7.5911.4 1,154,5 2.109.9 3.0 1.215.I} 1.172.11 573.0 NIA
IV N/A N/A N/A N!A 330.0 I. 1511.0 1.395.0 (O 1.0 N/A
1989t
NIA N/A N/A N/A -Slg.0 949.{} 1,392.1} ] ,820.1} N/A
11 N/A N/A NiA N/A -727.0 9111.ll ] .6911.ll 1.382.{I N/A

Sources: lndicadores de ( ' o y u n t u r a (various issues) and the ('enlral P,ank {71 Algemina.
~Financial services include profils and dividends, inlcresi paynlcnls and received.
',is based on preliminary figures.
 INFLATION 1N ARGENTINA
rules for the nominal anchors and to design a
strategy to end the freeze.
3. THE STOP AND GO CYCLE
The first adjustment was undertaken in April
1986 with the announcement of the "flexibiliza-
tion" phase of the program. On April 4, there
was a devaluation of the exchange rate, accompa-
nied by the introduction of a crawling peg
system, and increases in wages and prices of
public sector enterprises.17 Despite the flexibili-
zation in policies, the government continued to
control prices in the private sector, although
increases would be allowed in the future when
justified as the result of higher costs.
This flexibilization was necessary in view of the
persistence of inflation, and the inability to
withstand an overvaluation of the domestic
currency. It was prompted by the acceleration in
inflation in March 1986 and by the continuous
deterioration in the current account and the
budgetary situation (see Tables 2 and 3). The
reduced access to foreign financing, as a result of
the debt crisis, imposed an additional limit to the
sustainability of the exchange rate freeze.
(a) Price flexibilization and the resurgence of
inflation
The introduction of the April package was
perceived as an acceptance on the part of the
authorities that full price stability was beyond
their reach and that they were now aiming at
keeping inflation within "'reasonable" bounds.
With this acceptance there was also an accelera-
tion in inflation, which reached 6.8% in July
1986 (Table l).
A more serious problem was the lack of a
comprehensive strategy to maintain inflation
within reasonable bounds. The flexibilization
stage left the system without effective nominal
anchors. The exchange rate and public sector
prices (central anchors in the initial package)
were to be adjusted according to past inflation in
order to avoid further deterioration in their
relative prices. In fact, nominal increases in these
two variables exceeded inflation between April
and July. Nominal wages, the third anchor in the
initial program, were increasingly determined
through negotiations between unions and indus-
trialists. Since monetary policy continued to be
accommodating, there was no nominal variable
in the system that could provide an anchor for the
price level.
In such a situation nominal shocks have a
destabilizing effect on inflation. A one-time
979
increase in the price level will be quickly trans-
mitted to wages and the exchange rate and will
result in a permanent increase in the rate of
inflation, is
The main reason for the acceleration in infla-
tion following flexibilization became a controver-
sial issue. Broadly speaking, there are three
interpretations of this episode, one emphasizing
problems in the behavior of nominal variables, a
second stressing the imbalances in relative prices
during the initial freeze, and a third attaching a
larger weight to the fiscal and quasi-fiscal imbal-
ances.
Frenkel and Fanelli (1987, p. 103) and Machi-
nea and Fanelli (1988, p. 142) link the accelera-
tion in inflation to cost-push factors, primarily
increases in nominal wages. The evolution of
hourly wages during this period is presented in
Table 1. As can be noticed, hourly wages
increased continuously during the first months of
the plan, while there was a slight acceleration in
April. Real hourly wages, however, had been
deteriorating since the beginning of the plan, and
the April and May increases were not enough to
restore their real value to pre-austral levels. The
other two major cost factors, the exchange rate
and public sector prices, were not drastically
increased in this period (see Table 1). Thus, the
evidence does not indicate that the acceleration
in inflation between April and June was driven
by cost-push factors. > The story is somewhat
different in July, where nominal increases prob-
ably had an important effect on the increases in
inflation.2~' indeed, real wages (as well as hourly
wages) peaked in July and were later eroded by
further increases in inflation.
Canavese and di Tella (1988), on the other
hand, consider that the resurgence of inflation
during the flexibilization period was due to the
imbalances in relative prices that existed at the
time of the freeze. They argue that "Pressures
stemming from the inevitable need to realign
prices troubled the Austral Plan the most and
made the unfreezing essential. But at the same
time the end of the freeze had a troubling effect
on inflation, as it became apparent the following
year" (1988, p. 159). If this argument is correct, it
can explain why a period of high inflation should
be followed by another period of low inflation.
This argument, however, fails to explain what
determines the rate of inflation in the new
equilibrium. More importantly, it does not pro-
vide a rationale for the acceleration of inflation
that occurred after April. ~1
The third interpretation puts the emphasis on
the continuous and excessive increases in the
money supply and the loosening of the budgetary
situation (see Tables 1 and 2) that became
980 WORLD I)EVf{I.OPM[!N I
evident during the first quarter of 1986.
addition, the large seigniorage levels that pre-
wtiled during the period (nee Table 2) wcrc
inconsistent with the target for annnal inflation in
the low single digits. The April flcxibilization
thus took place in an expanding econorny with
high consumption and increasing budget imbal-
ances. U n d e r these circnmstanccs, a resurgence
of inflation was all but inevitable.
T h e fiscal view can be used to explain why
increases in inflation had to hc expected. The
existence of a rehttivcly large budget deficit
rcqttiring seignioragc bctv,'ecn 3 and 4% ol +G D P
established a floor for the rate of inflation. The
sharp acceleration in i n f l a t i o n that t o o k place
during July and August, however, cannot solch'
be explained on fiscal grounds.
A comprehensive exphmation of inflation dur-
ing this period requires a combination of the
ideas outlined above. The large budget deficits
and high seigniorage levels rnadc inflatiun Utl-
avoidable. Based on recent cMimates of the
elasticity of the denland for money with respect
to the rate of inflation, hov¢cver, seigniorage
levels in the ran,,c of q"i, of G I ) P need to bc
financed with a motlthlv rate of infhttion of
approximately 5%. The acceleration of July
appears to have hcen caused bv additional
factors. Although cost-push forces were probalqy
important, they would have been less destabiliz-
ing if the system had retained a nominal anchor.
(b) T]l{' firLYl sFriug iffan
File July 198t+ inflation rate brought the prog-
ram to a critical point: the situation '~,dts getting
out of control and urgent changes were needed to
bring it back on course. A new teatn took control
of the central bank at tile end of Augt, st and
immediately adopted a ,,'cry tight stance regard-
ing expansions in M I (Table 1). > Money was m
practice the only nonlinal anchor in this program.
The first spring phm did not introduce measures
to deal with the fiscal imbahmces (since accord-
ing Io the authorities the fiscal situation was
ftu~dalnentally sound) and instead placed its
emphasis on the problems created hy inertial
torees: it established ceilings (3%) for monthly
increases in prices in tile priwne and public
sectors as well as limits on wagc increases.
The first spring phm had limited success in
controlling inflation, Inflation did recede, but
remained at relatively high levels for the rest of
tile year. The underlying situation was not
conducive to attaining price stability. Despite
tight money and higher interest rates (the nomi-
nal interest rate almost doubled in August), real
In wages, industrial l~roduction, and cot>eruption
remained rchttivcly high, although ;tt solne\,,hal
lower levels than previously, while the external
situation continued to deteriorate. While there is
disagreement among obsct,,ers about the si/c el
the fiscal inlbalancc during the third qtlilrtel-Ol
1986 (Table 2), there is no question that the fiscal
alld mOllelalv aeeOtll/ts greatly deteriorated in
the last qual?ter of that year. 24
The initial :mchors by then had been aban-
doned, and money rcnlainccl the only nominal
anchor. Dcspite anntmnccmcnts that tile size tfl
tile dcvaluations and tilt' inercascs in pulqic
sectors prices would bc limited to 3'lq, per nlonth.
thc~, were ill effect indexed, rising consistenth
above the official guideline, l ' h c package relied
alnloM entirely on tight moncx, but tile sustaill-
ability of this strategy ~x~ls very difficult bCC'attSt:
there ~+.;ts ;m inconsistency bCtVvrCClI the g r o w t h
l+¢ltes o f IllOncv lind o t h e r llOlllillal \'~lI-i;ll)lcs.
(c) Re.sut:gum'c o/'i,,U/ati+,n am/lhc ,second/?cc:c
Inflation increased once more m January ]9~7.
and there was an even larger increase in l:ebru
arv. This rise m inflation was particularly trouble-
some since it h~ok place at a time when monctarv
policy was tight as measured bv the gro'ath of MI
and the high real itltereM rates or l,~, the
expallsion of the 111o11CtalV base. ~I1icll ctH1-
tracted in ,hmuar\. and Fel,ruarv (sue l:igurc ~
and Table I). ()nee again, the authorities re-
sorted to a price freeze in order to regain control
over the inflationary process. This polio} re
sponsc imlicatcs that the authorities ,acre under
the impression that the underlying "'fundamen-
tals" were m phtce and that inflation was acceler-
ating Ltsa restlll of +11onccollOlllie" fofees. l i f t s
i n t e r p r e t a t i o n could have Is,t e n rcinforc-cd b \ the
fact that infhttion 'a,as increasing at a time ~qlen
m o n e t a r y policy was tight.
Three remarks are useful for the intcrprctatitm
of these events, l:irst, although monetary policy
remained tight durillg MOst of the spring plan,
including January and February, it had been
expansionary in the last two months of 19,'q6.
Second, there was an important fiscal imbalance
in the last quarter of 1986 which remained in
place m the first quarter e l 1987 ,:tnd was likely to
stay there for the rest of the year. The existence
of a large fiscal deficit tn;ide the stabilization
policy Jess credible and, more importantly.
threatened the sustainabilitv of tight m o n e y ,
which eventually had to be relaxed. Third. firms
may have overreacted in their price adjustments
ill .lanuary and February (once price controls
were partly rclaxcd) and increased their prices in
 INFLATION IN ARGENTINA
excess of what was warranted by the "fundamen-
tals" in order to hold a cushion for the eventual
imposition of a new round of price controls (to
which the authorities had already shown some
proclivity).
Inflation was becoming a major liability for the
government, and the problem was particularly
acute because 1987 was an election year. The
government response was a new round of direct
controls through the introduction of a price and
exchange rate freeze which was supplemented by
a step adjustment in wages and public sector
prices (to compensate for past inflation) followed
by a freeze. Once again, no effort was made to
provide a long-term solution to the underlying
fiscal problem.
The February program, as most of the other
reform efforts had some transitory gains on the
inflation front, with inflation falling substantially
in April and May. 25 Direct controls can be
effective in the short run. This time, however,
the success was much more short-lived because
the imbalance in the underlying fundamental
variables was complicated by political problems
that eventually led to mismanagement of nominal
w~riables.
The main political development was the
appointment of Carlos Alderete. a union leader.
as Minister of Labor in April. This led very
quickly to a change in policy, particularly regard-
ing wages, which was announced on May 9. The
new measures were the result of an agreement
(the Acuerdo del 9 de mayo) between the
economic team, led by Sourrouille, and Alder-
ete. They included increases in wages and public
sector prices, while prices in the private sector
would continue to be subjected to government
controls, but under a more flexible policy.
(d) The two latest in/lation-stabilization ~ycles
From spring 1987 on, the overall economic
situation underwent a steady deterioration.
Loose monetary management, and large budget
deficits led to a new acceleration in inflation,
reaching 13% in August and 19.5% in October,
when the government launched a new ministabi-
lization program. Once again, the acceleration of
inflation appears to have been caused by a
mixture of fiscal imbalances and anticipation of
controls. The increase in inflation prompted the
imposition of price controls, making the expecta-
tions of their reimposition self-fulfilling.
The October package was different from the
previous ones because this time the authorities
announced measures to provide some longer-
term relief to the fiscal imbalance and to start a
981
structural adjustment process in the economy.
Most of the reduction of the budget deficit was
going to take place through increases in taxes,
while there were basically no attempts to reduce
government expenditure of the central govern-
ment. On the other hand, there was an announ-
cement of a firm commitment to privatize some
public enterprises and to start a process of trade
liberalization.
The outcome of this program, as one might
expect, was a transitory reduction m inflation
while the controls were in effect, followed by an
increase in inflation at a h|ter stage, once the
controls were relaxed (in January 1988). From
that time on, inflation continuously accelerated,
reaching 28% in August 1988.
The Phm Primavera (second spring plan) was
the last package put together by the Austral team
and was intended to provide a response to this
inflationary outburst. This plan was based on
guidelines for increases in nominal variables, and
reductions in the quasi-fiscal deficit. The ex-
change rate and public sector prices recovered
their role as nominal anchors, as their monthly
increases were preannounced for the subsequent
few months, and guidelines were negotiated with
private firms. Private sector wages, on the other
hand, were allowed to be freely determined
through negotiation between firms and workers.
Tight money and high interest rates were a
central part of the plan, and in fact represented
its "'orthodox" component.
The program achieved the same, or even
higher, degree of short-run success than previous
stabilization efforts. As in previous cases, infla-
tion fell substantially and the exchange rate was
stabilized, while interest rates remained high in
real terms. Despite the tough monetary policy
and some initial improvement on the fiscal side,
the program did not survive its first months. Its
failure, although predictable from the outset,
became apparent in February 1989 and led to the
worst acceleration of inflation ever experienced
in Argentina, resulting in hyperinflation.
4. E V A L U A T I O N OF T H E R E C E N T
EXPERIENCE
The macroeconomic developments of the late
1980s show quite clearly that the Austral plan did
not succeed in bringing down inflation on a
sustained basis. On the contrary, during this
period inflation became more unstable, and in
the last period of the Austral era reached hyper-
inflation. The program, however, left useful
lessons regarding the design of heterodox stabili-
zation programs, the difficulties of sustaining this
type of effort, and the consequences of failure.
982 WORLD I)EVEI/)PMI{N I
(a) Earh' developments
A b a h m c e d ewfluation of this plan should
distinguish b e t w e e n the original strategy for
stopping inflation, with particular a t t e n t i o n to
the measures of June 1985, and the subsequent
efforts for inaintaining price stability. T h e initial
package was by and large well designed a n d
consistent, and p r o v i d e d a soutrd first step
toward reducing inflation. It was not e n o u g h .
however, to m a i n t a i n price stability for a pro-
longed period. F u r t h e r m e a s u r e s had to be t a k e n
m o r d e r to consolidate the stabilization effort.
particularly on the fiscal side. prior to the
removal of controls. In addition, the success of
the strategy r e q u i r e d the a u t h o r i t i e s to bc r e a d \
to accept sonle costs, in t e r m s of increases in
u n e m p l o y m e n t or at least p o s t p o n e m e n t of
growth, if the overall m a c r o e c o n o m i c conditions
,11ilde it n e c e s s a r y .
F u n d a m e n t a l refom}s of the fiscal side were
necessary since the initial adiust,13cnt was preca-
rious and of a transitory nature. Nevertheless. ,3(.t
drastic m e a s u r e s were i n t r o d u c e d to cnstu-e
p e r m a n e n t reductions in g o v e r n m e n t expendi-
ture a n d no efforts were u n d e r t a k e n to c n s t u e
that the increase in r e v e n u e s largely resulting
from transitory' m e a s u r e s would be sustained.
A fiscal reform and a restructuring or privatiza-
tion of public sector cnte,-priscs were inlperati~.c.
but ,lot t,,ldertake,]. 2''
A more difficult issue, from a policy pct+spec -
tivc, was how to r e s p o n d to the early recovery of
the eco,lOlll_y that started hi the fourth q u a r t e r e l
1985. A l t h o u g h one of the o b i c c t h e s of the
h e t e r o d o x package is to reduce the costs of
bringing down inflation, the strategy does not call
for a rapid e x p a n s i o n in o u t p u t in the early
stages. T h e r e is no consensus regarding the mare
reason b e h i n d the early e x p a n s i o n in e c o n o m i c
activity, in A r g e n t i n a . It might have b e e n caused
by a c h a n g e in income distribution (the reduction
in the inflation taX redistributed income in tavor
Ot w a g e e a l , l e l S ) , b\' ;t relaxation it] m o n c t a r \
and fiscal policies, or by ;,n i m p r o v e m e n t m
efficiency its a result of the s h a r p reduction in
inflation. Nevertheless, it is q u e s t i o n a b l e
w h e t h e r this was a welcome d e v e l o p m e n t at the
c a r l \ stages e l a stabilization progranl in a,i
eco,3omv with widespread price co,ltrols.
A demand-led economic expansion was a clear
threat to price stability. The policy choices were
difficult, since thcv would very likely require the
acceptance of some of the costs that the heter-
odox package was designed to awfid. N e v e r t h e -
less. f u r t h e r fiscal t i g h t e n i n g and a restrictive
,llonetarv policy were lleCeSSL,i-v ill o r d e r to
e o l n p e n s a t e for the increase in private sector
d e m a n d . It was advisable to p t u s u e ;i polio 5 el
excess supplies at least until most prices wcrc
liberalized.
T h e lack of policy response to the develop
,llCIltS hl these two ;.tFCHN WilS i,llpor[:lllt bcc.'tusc
it p r o v i d e d e v i d e n c e on the way in which the
authorities were to address potential prol~lems.
In addition, with the benefit (./1 hindsight, it
indicates Ihi,t tiler had not t h o u g h t t h r o u g h the
steps that would be necessary to liberalize price',
without a resurgence in inflation.
(b) R e m o v a l O/c(mtroL~
The strategy for pricc liberalization is a crucial
aspect of a h e t e r o d o x p r o g r a m . Price stabilit 5 can
only be fully credible ill an e n v i r o n m e n t of f r e d ' ,
determined prices. T h e overall scheme for liber
alizing prices is critical and needs as much
t h o u g h t as the design of the initial phase (./1 the
p r o g r a m . Particular a t t e n t i o n should be given to
tim timing, conditions and mechanics of the
,CI3](/VIll o f controls.
It was argued in the previous section that price
controls were a Cl-Ucial e l e m e n t for stopping
inflation. Paradoxically. the main a d v a n t a g e el
controls is also their main drawback. The quick
reduction in inflation ]hal can bc achieved
t h r o u g h controls can m a k e the authorities over-
confident and lead then] to u n d e r e s t i m a t e the
seriousness (.11 a,lV existing tulderlyhlg inlba-
hmccs. In t~articular, it might lead t h e m to think
t h a t 11(.I f u r t h e r m e a s u r e s arc IICCCSS~,,'V 1t1 St, SU4ill
the early gains against inflation. 1,3 addition.
since controls proved to be an effective way to
bring a b o u t price stabilih', the a u t h o r i t i e s mi,,hl
b e c o m e reluctant to eliminate t h e m . T h e process
can bc further c o m p l i c a t e d if the freeze o~
n o m i n a l 4,1cho,s is extcndu,:.l bcyo,ld a reason-
able time and distortions in key relative prices
b e c o m e a p p a r e n t . 2T This is indeed a ma o,
w e a k n e s s of the h c t c r o d o x upproaeh.
T h e removal of controls, h o w e v e r , shouM bc ',l
priorit~ for the p r o g r a m . ( ' o n t r o l s should bc
r e m o v e d gradually and u n d e r a situation o l
generalized exces¢, supply. Tight fiscal and m o n e -
tary policies should r e m a i n in phtce during the
period of price "+flexibilization.'" In A l g e n t m a
"'flexibilization'" was initiated at a time when the
e c o n o m y was rapMly e x p a n d i n g and the current
account deficits were increasing. The public
accounts had also been deteriorating. Price
flexibilization was thus not u n d e r t a k e n u n d e r the
best circutnstai3ces.
A more serious p r o b l e m was that with the
r e m o v a l o f c o n t r o l s the c c o n o m v was left w i t h ,3(.)
130111i,1..,1 .'l,lehors. a , l o m / , l a ] ~t,lcho,- w'Hs p~,,-ticu
 INFLATION IN ARGENTINA
larly important since in the absence of controls
prices and wages would be determined by market
forces. Since the exchange rate, public sector
prices, and the money supply were basically
adjusted to accommodate inflation, there was no
nominal variable to anchor the rate of inflation.
Given the necessary adjustments in public sector
prices and the exchange rate, money should have
played a more active role in this period, and the
authorities should have pursued a policy, from
that time forward, of untying devaluations from
inflation.
An alternative sequencing might have pro-
vided more stability to the price level. In the
Austral plan the removal of controls coincided
with the flexibilization in the management of the
main anchors of the system. A gradual decontrol
of private prices followed by a sequenced adjust-
ment in wages, public sector prices and the
exchange rate would have had a better chance of
success.
(c) The importance of foreign debt and external
developments
It is difficult to assess the extent to which the
external situation complicated the stabilization
effort. An extreme view is that of Canavese and
di Tella, who consider that "repayment of the
debt was the single most important reason for the
relative failure of the plan" (1988, p. 166).
Although external debt service introduced an
additional burden to the fiscal adjustment (in-
terest payments were approximately 5% of
GDP), the country was able to get additional
funds to cover more than half of these payments.
Actual net external transfers during 1985-87
were roughly 2% of GDP per year. Thus, the
fiscal burden of interest payments, while impor-
tant, does not seem to have been the critical
problem for the program.
The debt problem, however, created other
types of difficulties for the stabilization program.
First, it greatly complicated the reliance on the
exchange rate as the main nominal anchor of the
system. In the absence of access to foreign
borrowing, the exchange rate would have to
adjust if there were pressures on the external
sector. Second, and probably more important, it
increased the uncertainty about the medium-
term sustainability of the program. Even if funds
had been provided in the past to service the debt,
there were questions as to whether those funds
would be forthcoming in the future. The debt
issue also created a problem regarding manage-
ment of public finances, since the government
would have to raise taxes in the future to
continue servicing external debt.
983
The external situation has been complicated by
a significant deterioration in the terms of trade
during the last two years. While it would be
unfair to attribute the failure of the program to
the service of the foreign debt, its burden and the
resulting increase in uncertainty definitely com-
plicated macromanagement during this period.
One thing is clear: external developments were
not favorable for the success of the program.
(d) Lessons and policy issues
The Austral plan, despite its failure, has useful
implications for the future design and implemen-
tation of stabilization programs in general and
heterodox programs in particular. First, it has
shown that stopping inflation on a sustainable
basis is essentially a long-term effort which
requires persistence and discipline. The duration
and scope of this effort will be inversely related
to the length of the inflationary process, the
inflation rate prior to the program, and the
number of previous failures. Income policies can
bring down inflation quickly, but this short-run
success needs to be accompanied by a sustained
fiscal and monetary effort to ensure the mainte-
nance of price stability.
Second, the Argentine experience is particu-
larly illuminating regarding the advantages and
disadvantages of price controls. Price controls
were very effective initially to break the inertial
forces as the economy moved from high to low
inflation. It is unlikely that the rapid reduction in
inflation at the beginning of the program could
have been achieved in the absence of price con-
trols. Price control, however, is an instrument
that serves a very specific purpose - - control of
the inertial aspects of the inflation process. To be
effective, it must be used cautiously, and on a
transitory basis. Controls should be gradually
removed as soon as the authorities perceive that
the underlying inertial forces have been subdued.
One problem with price controls is that they
could send a "'wrong" signal about the success of
a program. In most cases price controls are an
effective tool to bring down inflation, at least
temporarily. Indeed, in Argentina inflation came
down initially every time price controls were
introduced. Unfortunately, inflation went up
~X
every time they were removed.- Thus, in gene-
ral it is very difficult to infer the underlying
inflation rate on the basis of the rate observed
during a period when controls are in effect. An
additional problem is that their short-run effec-
tiveness can lead the authorities to use price
controls each time that inflation starts to acceler-
ate. Such a strategy was observed in the recent
984 WORLD DEVELOPMENI"
A r g e n t i n e experience, w h e r e price controls be-
came the p r i m a r y i n s t r u m e n t to control inflation.
T h e r e p e a t e d use of controls quickly b e c o m e s
a tool that works against any stabilization effort.
T h e inflation cycles s h o w n in Figure 2 illustrate
this p r o b l e m . T h e inflation o u t b u r s t s that occur-
red prior to the actual imposition of controls can
p r o b a b l y be best e x p l a i n e d by the e x p e c t a t i o n s of
the private sector. If firms expect a price freeze,
they will a t t e m p t to e n t e r the freeze with a high
absolute price. A l t h o u g h this price might bc
a b o v e the m a r k e t - c l e a r i n g level at the time of the
freeze, it will be on average right while the freeze
r e m a i n s in effect. This point of view is s u p p o r t e d
by the b e h a v i o r of prices during the period u n d e r
c o n s i d e r a t i o n . In A r g e n t i n a , price controls were
e n f o r c e d at the wholesale level. As is a p p a r e n t
from T a b l e 1, increases in wholesale prices were
larger prior to each of the m a j o r freezes (particu-
larly in J u n e 1985, O c t o b e r 1987, and J u n e
A u g u s t 1988), a n d smaller after the freeze. 'Fhesc
larger increases prior to the freeze p r o v i d e d
e n o u g h cushion to m a i n t a i n a lid on price
increases during the p e r i o d of controls and at
least partly explain the lack of shortages d u r i n g
these periods.
T h e inflation-stabilization cycle that has b e e n
o b s e r v e d since J u n e 1985 was to some extent
related to the stabilization strategy followed by
the g o v e r n m e n t . T h e fact that the g o v e r u m e n t
revealed its decision to use price controls once
created e x p e c t a t i o n s that they could be used
again in the future. In this e n v i r o n m e n t , small
increases in inflation could very quickly spark an
acceleration process in anticipation of the
reimposition of controls. T h e g o v e r n m e n t could
eventually r e s p o n d by imposing new controls,
m a k i n g the e x p e c t a t i o n s self-fulfilling.
NOTES
1. For a more detailed dcscription ot these episodes
see Kiguel and Liviatan (1988) and dc Pablo and
Martinez (1988).
2. Seigniorage was measured as the changcs in M 1 as
a percentage of GDP. In Argentina MI, as opposed to
the monetary base, is the appropriate monetary aggre-
gate to measure seigniorage because the central bank
remunerates reserve requirements on interest bearing
deposits on time.
3. For a detailed comparison of the two programs
see Blejcr and Liviatan (1987). That paper also
discusses the similar behavior of macroeconomic wtri-
ables during the early stages of the programs.
4. Due to lack of accurate statistics on public sector
expenditures, there is no consensus among observers
Despite their a d v a n t a g e in reducing inflatitm,
price controls can be costly on two grounds.
First, they can be difficult to r e m o v e and h e n c e
lead to distortions in relative prices. Second, and
p r o b a b l y more i m p o r t a n t , a failure of this type of
p r o g r a m can increase instability in the inflation
process.
A r g e n t i n a ' s e x p e r i e n c e of the last few years
has m a d e quite clear that tight m o n e y c a n n o t be
sustained in the presence of a large fiscal
imbalance. This lesson, of course, is well known
from the research of S a r g e n t - W a l l a c e (1981), and
is very clear from recent A r g e n t i n e experiencc.
Figure 2 shows inflation and interest rates on
deposits since the b e g i n n i n g of the Austral plan.
Tight m o n e y was used to control inflation twicc:
from August 1986 to Febrttary 1987, and from
O c t o b e r 1987 until J a n u a r y 1988. In n c i t h e r of
these cases was the policy able to control infla-
tion on a medium-terna basis. In both cases
inflation accelerated during thc period in which
fight m o n e y was in effect.
T h c Austral plan has a d d e d a new c h a p t e r
to the unsuccessful efforts to stop inflation. Des-
pite the sophistication of the original design of
the plan and the battery of follow-up p r o g r a m s ,
inflation is still alive a n d price stability still
a p p e a r s as a distant goal. It seems that few
lessons were learned from previous faihtres, as
similar mistakes were repeated. T h e most impor-
tant lesson from the Austral plan is that sophisti-
cation is not a substitute fl~r addressing funda-
mental imbalances. T h e r e is no substitute for
persistence and continuity in a stabilization
effort. It is t m f o r t u n a t e that each new failure
m a k e s price stability more r e m o t e and more
difficult to achieve.
about the exact magnitude of the size of the initial fiscal
imbalance. Nevertheless, all the available sources
indicate that there was a significant reduction in thc
budget deficit, which was cut by approximately two-
thirds from the levels prevailing at the beginning of
1985.
5. The similarities are spelled out in more detail in
Blejer and Liviatan (1987).
6. Two important factors that influence prices are
credit terms and the use of financial resources. Firms
that provide interest-free connnercial crcdit It) their
customers have to includc their financial costs in thc
price they charge. If there is a fall in inflation, firms
should react by reducing nominal prices, the size of the
reduction required depending on the average length of
these credits. A change in relative prices will occur
 I N F L A T I O N IN A R G E N T I N A
when there are differences in the duration of these
commercial credit lines provided by the various sectors.
On the cost side, there are likely to be changes in the
cost structure because as the economy moves to low
inflation, firms will increase the proportion of resources
that they use in production and reduce those used to
manage financial assets.
7. O n this point see Pazos (1972).
8, T h e government raised nominal wages by 22.6%
effective at the end of June. This increase, however,
was not enough to compensate for past inflation and
was certainly smaller than the accumulated devaluation
of recent months.
9. The freeze did not apply to goods with seasonal
supplies (mainly meat, fruits and vegetables) which
were instead subject to fixed mark-ups over costs.
10. U n d e r perfect capital mobility the domestic in-
terest rate will equal the toreign interest rate plus the
expected rate of depreciation of the exchange. For the
purposes of our discussion, however, the results will be
derived either by using equation (2) under perfect
capital mobility conditions where one would interpret
~" as the expected rate of devaluation.
11. After that time, capital flows slowed mainly
because the government imposed additional restric-
tions on capital movements.
12. See, for example, H e y m a n (1987) and Frenkel
and Fanelli (1987).
13. I am grateful to Enrique Szewach for pointing out
the legal obstacles to the implementation of the desagio
in the absence of a new currency.
14. Most of the public sector domestic debt was in the
form of deposits of commercial banks in the central
bank and other types of ~'forced'" lending through the
banking system. A comprehensive study of these
aspects will be done in future research.
15. For a comparison of the program of the 1981Js see,
for example, Blejer and Cheasty (1988) and Kiguel and
L]viatan (1989).
16. Two facts can be used to question the soundness
of these increases in the m o n e y supply. First, in spite of
its size, the increase in money supply did not produce
any significant reductions in interest rates. Second, in
the fourth quarter the balance of payments turned into
deficit after being in surplus for the two previous
quarters, thus suggesting that at those interest rates
there was not an excess d e m a n d for money.
17. For a more detailed discussion of the measures
see de Pablo (1987).
18. A d a m s and Gross (1986) provide an excellent
discussion of the difficulties of controlling inflation with
exchange rate indexation and monetary accommoda-
tion.
985
19. The large increases in hourly wages in the con-
struction industry during April could convey the im-
pression that cost-push factors were important in that
sector. A more careful examination of the data,
however, indicates that wages in this sector experi-
enced hardly any increase during the first m o n t h s after
the introduction of the Austral plan. Thus the April
increase basically restored relative wages.
20. The interpretation of this is complicated by the
fact that during this period some labor unions obtained
significant wage increases. It is, however, difficult to
assess the extent to which these increases merely
"'officialized'" previous wage increases that were
already reflected in the actually paid (as opposed to the
contract) wages.
21. For a thorough evaluation of this argument see
Rodriguez (1988).
22. See, for example, Fernandez and Mantel (1989)
and Kiguel and N e u m e y e r (1989).
23. The drastic change in monetary policy adopted
was necessary to ensure the consistency of the program.
The discrepancies between the economic team (led by
Sourrouille) and the central bank authorities (led by
Concepcion) are well d o c u m e n t e d in the Argentine
press of the period. At the same time, the drastic
change in monetary stance in August provides indirect
evidence that the m i s m a n a g e m e n t of m o n e y supply was
considered, at least as some government levels, as one
important force behind the resurgence of inflation.
24. For cyclical reasons the budget deficit is usually
larger in the last quarter of the year. Nevertheless, the
increase in the deficit toward the end of 1986 cannot be
fully explained by seasonal factors (it was, for example,
much larger than in the last quarter of 1985).
25. There was some reduction in inflation in March as
well, hut this is not fully reflected in the official
statistics due to the way in which the CPI and WPI are
computed.
26. A timid fiscal reform was introduced in an
October 1987 plan, which included new taxes and
changes in the rates of existing ones. This reform,
however, was too little too late and it introduced
additional distortions in the economy (i.e., it was likely
to reduce financial intermediation and restrict im-
ports).
27. This is the typical problem observed in the so-
called populist stabilization programs (e.g., the 1973-
75 Peronist program, and the recent Peruvian one)
where in addition price controls are used as a substitute
for the correction in fundamentals.
28. Interestingly enough, there were no widespread
shortages in any of these cases. Thus, the acceleration
in inflation following the removal of controls cannot be
easily linked to the existence of "repressed" inflation
due to excess d e m a n d pressures.
986 WORLD DEVEL()PMENT
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