Stabilization programs in chronic-inflation countries: Evidence from Latin America

Palazzo, Gabriel and Rapetti, Martin and Waldman, Joaquin (2025): Stabilization programs in chronic-inflation countries: Evidence from Latin America.

Abstract

Chronic inflation has affected Latin America for decades, leading to many stabilization attempts. We develop a novel database with 46 stabilization/disinflation programs across 13 Latin American countries between 1970-2020. We classify them as failures, temporary stabilizations, and lasting stabilizations to study their differences. Our main findings are: 1) programs have failed to stabilize very often; 2) the nominal exchange rate acts as a de facto anchor, decelerating faster than inflation; meaning that the real exchange rate appreciates during stabilization; 3) lasting stabilizations begin with stronger fiscal and balance of payments (BoP) positions; 4) lasting stabilizations are preceded by BoP and fiscal adjustments associated with high GDP contractions; 5) lasting stabilizations keep fiscal accounts balanced for several years after programs are launched; 6) stabilizations typically boost economic growth in the short run; 7) the current account of the BoP worsens during the stabilization process; 8) temporary stabilizations are interrupted by domestic currency depreciations; and 9) many stabilization experiences end up in currency crises despite their success in ending chronic inflation.

• Item Type: MPRA Paper
• Language: English
• Keywords: inflation; stabilization programs; Latin America
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E65 - Studies of Particular Policy Episodes; N - Economic History > N1 - Macroeconomics and Monetary Economics ; Industrial Structure ; Growth ; Fluctuations > N16 - Latin America ; Caribbean

References

Aisen, A. (2004). Money-Based vs. Exchange-Rate-based Stabilization: Is there Space for Political Opportunism. IMF Working Paper, WP/04/94

Aromí, J. D. (2021). Large current account deficits and neglected vulnerabilities. IMF Economic Review, pp.1-27.

Bebczuk, R., Galindo, A., & Panizza, U. (2010). An evaluation of the contractionary devaluation hypothesis. In Economic Development in Latin America (pp. 102-117). Palgrave Macmillan, London.

Burstein, A., Eichenbaum, M., & Rebelo, S., (2005). Large devaluations and the real exchange rate. Journal of political economy, 113(4), pp.742-784.

Calvo, G. A. & Végh, C. A. (1994). Inflation stabilization and nominal anchors. Contemporary Economic Policy , 12(2), 35-45.

Calvo, G. A. & Végh, C. A. (1999). Inflation stabilization and BOP crises in developing countries In Handbook of macroeconomics , 1, 1531-1614.

Cavallo, A., Neiman, B., & Rigobon, R. (2019). Real exchange rate behavior: new evidence from matched retail goods. Harvard Business School.

Darvas, Z. (2021). Timely measurement of real effective exchange rates. Bruegel Working Paper 2021/15

De Gregorio, J., Guidotti, P., & Végh, C. (1998). Inflation stabilization and the consumption of durable goods. The Economic Journal , 108(446), 105-131.

Dornbusch, R. (1976). Expectations and Exchange Rate Dynamics. Journal of Political Economy, 84(6), 1161–1176. http://www.jstor.org/stable/1831272

Dornbusch, R. & Simonsen, M. H. (1987). Inflation stabilization with incomes policy support: a review of the experience in Argentina, Brazil and Israel. National Bureau of Economic Research Working Paper 2153

Easterly, W. (1996). When is stabilization expansionary? Evidence from high inflation. Economic policy, 11(22), 65-107.

Fischer, S., Sahay, R. & Végh, C. A. (2002). Modern hyper-and high inflations. Journal of Economic literature, 40(3), 837-880.

Frenkel, J. A. (1977). The forward exchange rate, expectations, and the demand for money: The German hyperinflation. The American Economic Review, 67(4), 653-670.

Frenkel, R. (1979). Decisiones de precio en alta inflación. Desarrollo Económico, 19(75), 291-330.

Frenkel, R. (1983). Mercado financiero, expectativas cambiarias y movimientos de capital. El trimestre económico, 50(200 (4), pp.2041-2076.

Frenkel, R. (2020). Globalization and Financial Crises in Latin America. Brazilian Journal of Political Economy, 23, 437-455

Frenkel, R. & Rapetti, M. (2009). A developing country view of the current global crisis: what should not be forgotten and what should be done. Cambridge journal of economics, 33 (4), 685-702.

Gould, D.M. (1996), Does the choice of nominal anchor matter?, Working Paper N° 9611. Federal Reserve Bank of Dallas.

Hamann, A. J. (2001). Exchange-rate-based stabilization: a critical look at the stylized facts. IMF Staff papers, 48(1), 111-138.

Hamann, A. J. & Prati, M. A. (2002). Why do many disinflations fail? The importance of luck, timing, and political institutions. International Monetary Fund WP/02/228

Heymann, D. & Leijonhufvud, A. (1995). High Inflation: The Arne Ryde Memorial Lectures. OUP Catalogue .

Ilzetzki, E., Reinhart, C. M., & Rogoff, K. S. (2021). Rethinking exchange rate regimes. National Bureau of Economic Research Working Paper 29347

Kehoe, T. J. & Nicolini, J. P. (Eds.). (2022). A Monetary and Fiscal History of Latin America, 1960–2017. U of Minnesota Press.

Kiguel, M. A., & Liviatan, N. (1989). The old and the new in heterodox stabilization programs. The World Bank, Working Paper WPS, 323.

Kiguel, M. A. & Liviatan, N. (1992a). The business cycle associated with exchange rate-based stabilizations. The World Bank Economic Review , 6(2), 279-305.

Kiguel, M. A. & Liviatan, N. (1992b). When do heterodox stabilization programs work?: lessons from experience. The World Bank Research Observer , 7(1), 35-57.

Krugman, P. & Taylor, L. (1978). Contractionary effects of devaluation. Journal of international economics , 8 (3), pp.445-456.

Krugman, P. (1999). Balance sheets, the transfer problem, and financial crises. International tax and public finance, 6, 459-472.

Laeven, L., & Valencia, F. (2020). Systemic banking crises database II. IMF Economic Review, 68, 307-361.

Mauro, P., Romeu, R., Binder, A., & Zaman, A. (2013). Modern History of Fiscal Prudence and Profligacy . IMF Working Paper, WP/13/5

Monnet, E. & Puy, D. (2019). One Ring to Rule Them All? New Evidence on World Cycles. IMF Working Paper, WP/19/202

Obstfeld, M. & Rogoff, K. (1995). The mirage of fixed exchange rates. Journal of Economic perspectives, 9 (4), 73-96.

Pazos, F. (1969). Medidas para detener la inflación crónica en América Latina. Centro de Estudios Monetarios Latinoamericanos.

Reinhart, C. & Végh, C. (1994). Inflation stabilization in chronic inflation countries: The empirical evidence. Banco Central del Uruguay. Mimeo

Reinhart, C. & Végh, C. (1999). Do Exchange Rate-Based Stabilizations carry the seeds of their own destruction? Mimeo .

Rodríguez, C. A. (1982). The Argentine stabilization plan of December 20th. World Development, 10(9), 801-811.

Uribe, M. (1999). Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies. Journal of Development Economics, 59(2), 295-318.

Uribe, M. (2000). The Analytics of Credible Exchange-Rate-Based Disinflation When Money Facilitates Firms' Transactions.

Veiga, F. J. (1999). What causes the failure of inflation stabilization plans? Journal of International Money and Finance , 18(2), 169-194.

Veiga, F. J. (2008). Why do stabilizations fail? Journal of Economic Policy Reform , 11(2), 135-149.