American Economic Association

The Austral Plan

Author(s): Daniel Heymann
Source: The American Economic Review, Vol. 77, No. 2, Papers and Proceedings of the Ninety-
Ninth Annual Meeting of the American Economic Association (May, 1987), pp. 284-287
Published by: American Economic Association
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The Austral Plan
By
DANIEL HEYMANN*
In recent years, several countries have ex-
perienced extremely rapid inflations, but
without total collapses of the national cur-
rencies. Argentina was one of those cases. By
mid-1985, the rate of price increase exceeded
30 percent per month; however, prices con-
tinued to be set in pesos and there remained
a sizeable volume of (short-term) nominal
contracts.
The treatment of such inflations poses
several questions: What is the desirable speed
of disinflation? What mix of instruments can
effectively act on prices without causing an
excessive fall in real income? How can prices
be kept on a stable or moderately rising
trend? The Austral Plan, announced in June
1985, combined fiscal measures with a
price-wage freeze and a monetary reform,
linked to a system for the conversion of debt
contracts. The program quite successfully
managed the transition to a much lower
inflation rate, while real output recovered
rapidly after an initial contraction. Still, in-
flationary forces remained strong: the prob-
lem of achieving a sustained stabilization
proved quite difficult to solve. This paper
briefly describes the program and its effects,
with some references to current debates on
stabilization policies. (See my 1986 study for
full discussion and details.)
I. The Initial Conditions
The Argentine economy went through a
drastic real adjustment in the early 1980's.
Between 1980 and 1984, the trade balance
passed from a deficit of 4 percent of GDP to
a surplus of 5 percent, industrial output
fluctuated sharply around a declining trend,
while investment steadily decreased. Infla-
tion accelerated from 90 percent per year in
1980 to around 700 percent in 1984. This
process was marked by successive shocks-
large real devaluations, a financial reform
that set negative real interest rates in order
to reduce business debts, and, later on, a
strong wage push. These shocks caused dis-
crete jumps in the inflation rate. The general
use of explicit or implicit indexing schemes
propagated the effects of the shocks, while
aggregate nominal demand sooner or later
rose to accommodate the higher inflation.
The public sector deficit rose to more than
15 percent of GDP in 1983. Although in the
following year the constitutional government
managed to reduce it somewhat, the deficit
remained very large. After 1980, the value of
interest due abroad rose sharply, partly be-
cause the government absorbed much of the
private debt. In addition, the "fiscal lag
effect" and more widespread tax evasion
diminished receipts. With few alternative
sources of financing, the Treasury was led to
demand massive loans from the central bank.
Relative prices varied much during this
period. In addition to the "noise" created by
inflation, there were more systematic shifts.
By 1984, the real exchange rate was 160
percent higher then four years before,' while
public sector prices had increased by around
50 percent. In the first part of 1985, the
authorities raised these prices further, in
preparation for the stabilization program.
Real wages oscillated widely, with a sharp
minimum in 1982 and a very rapid recovery
until late 1984; they fell in the first part of
1985, but were still noticeably higher than at
their troughs.
The 1980's inflation was even more rapid
than had been usual in Argentina. Money
demand dropped to around 2.5 percent of
GDP by mid-1985. People used various
*Economic Commission for Latin America, Buenos
Aires Office, and University of California, Los Angeles,
CA 90024. I alone am responsible for the opinions
expressed in this paper.
On a purchasing power measure based on the nomi-
nal exchange rate and the CPI inflation differential with
the United States.
284
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VOL. 77 NO. 2 STOPPING HIGH INFLA TION
285
means to synchronize payments and receipts.
In particular, foreign currency and bank de-
posits were in demand to be held over peri-
ods of only a few days. Most credit transac-
tions were made for very short periods, of a
month or less. Despite the uncertainty over
future prices, these contracts usually specified
a nominal interest rate in pesos. For longer-
term transactions (such as housing rentals), a
common practice was to adjust payments on
the basis of monthly price indices.
By mid-1985, public sector prices and
wages (both in the government and private
firms) were adjusted every month. In gen-
eral, wage increases seem to have used the
CPI inflation rate of the previous month as a
reference. Prices set by private firms often
changed at intervals of only few days. In
hyperinflations, it seems that price setting
gravitates to a "dollar standard" or similar
systems (see Costantino Bresciani-Turroni,
1937, p. 136). This did not happen in
Argentina; although price shifts were in-
creasingly synchronized, there was no single
price that governed the movements of the
whole set.
Inflation had strong real effects. Although
the poor performance of the economy (or the
recession that preceded the program) cannot
be attributed exclusively to the very high
inflation, it is clear that it seriously disturbed
economic activities. In any case, by June
1985, both the public and the government
saw inflation as perhaps the most urgent of
Argentina's economic problems.
II. The Program
Most hyperinflations have ended abruptly
without the use of price controls. According
to equilibrium theories, a credible fiscal an-
nouncement sufficed to stabilize expecta-
tions, causing prices to stop immediately
(Thomas Sargent, 1982). Other theories,
however, doubt that this mechanism oper-
ated, and stress rather the stabilization of a
"
key" price like the exchange rate (Francisco
Lopes, 1984; Rudiger Dornbusch, 1985). In
the Argentine case, "dollarization" was not
complete. It seemed reasonable to assume
that there remained significant inflationary
inertia (Roberto Frenkel, 1984), both be-
cause of the widespread use of indexing with
lags and also because of the difficulty in
automatically coordinating the stabilization
of individual prices. There was a clear risk
that fiscal and monetary measures by them-
selves would not be credible (since real tax
revenues depend on inflation), and would
have induced a large drop in output as well
as erratic price movements. On the other
hand, previous experience had shown that
income policies have little effect, or soon lose
it, if the growth in nominal demand is not
clearly under control.
The Austral Plan aimed at a sudden disin-
flation. A shock approach was chosen be-
cause of the urgency of the situation and
because a long, persistent disinflation with
tolerable output costs would be very difficult
to manage. The program had three main
parts. First, the government announced that
the central bank would stop granting credits
to the Treasury. The fiscal deficit would fall
drastically. Additional revenues were ex-
pected from several sources: the lower infla-
tion itself, higher duties on foreign trade, a
forced loan based on direct taxes and the
previously decided increases in public sector
prices. Government real wages and invest-
ment had been falling, and were not ex-
pected to rise in the near future. Further-
more, the drop in nominal interest rates
would reduce payments on bank reserves
(the "quasi-fiscal" deficit of the central bank).
Second, prices and wages were frozen. Third,
the austral was introduced as the new unit of
account. Currency and demand deposits were
converted on June 14 at a ratio of 1000
pesos to 1 austral. Subsequent payments de-
nominated in pesos (or indexed with pre-
reform prices), resulting from previous con-
tracts, would be made in australes at a
conversion rate that changed daily, in such a
way as to make the peso depreciate relative
to the new currency. This conversion tried to
avoid wealth transfers due to the abrupt
disinflation, by compensating approximately
the pre- and postreform inflation differential
(see Axel Leijonhufuud, 1984).
The program was designed to be robust, in
the sense that is did not depend on a single
mechanism to act upon prices. The three
main parts of the plan were meant to sup-
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286 AEA PAPERS AND PROCEEDINGS MAY 1987
port one another and to provide signals to
various segments of the public. At the same
time, the program "overdetermined" the
economy: the passage from the transition
phase (which was viewed as a first priority)
to a more permanent regime would entail the
removal of some constraints, with difficult
decisions to be taken as to the choice of
instruments and their management.
III. The Effects
Between June 1985 and March 1986 the
CPI increased at an average rate of 3 percent
per month. This inflation, although clearly
different from zero, was very low by previous
standards. The price controls, moreover, did
not produce noticeable disturbances in sup-
ply. Much of the increase in consumer prices
was accounted for by primary goods and
services; industrial prices, that had risen very
fast before the start of the program, stayed
almost constant. Given the lag between the
accrual and the spending periods of earn-
ings, it seems that unit real wages in the
private sector initially increased, then fell to
about their original values. By the end of
1985, many firms apparently started to ad-
just wages more or less in proportion to the
observed growth in the CPI.
There has been much debate about the
size of the fiscal deficit, mainly referring to
the treatment of central bank accounts.
However, the government's borrowing re-
quirements dropped sharply.2 The central
bank effectively stopped extending credits to
the Treasury, except for the transfer of for-
eign loans. Nevertheless, the money supply
expanded rapidly, due to the increase in
foreign reserves (originating both in a large
trade surplus and in capital inflows) and in
rediscounts, partly compensated by higher
reserve requirements. At the same time, there
was a large shift in real money demand.
Nominal interest rates fell noticeably, but
remained very much above the observed in-
flation rate in the initial months.3
Real output continued to fall immediately
after the program started. However, demand
and production soon began to recover
rapidly. In the fourth-quarter 1985, manu-
facturing GDP was already higher than in
the first quarter, when the recession had not
yet fully developed. The reduced price in-
stability probably caused changes in behav-
ior; for example, it is likely that the revival
of consumer credit was one of the reasons
for the recovery in demand.
The incipient stabilization, however, was
not consolidated. The residual inflation ap-
parently put a floor to expectations and
amplified the pressures for wage increases.
There was much public concern about the
possibility of a jump in prices at the end of
the freeze. The fiscal situation, although
much improved, still looked fragile: some of
the initial measures were transitory (like the
higher export taxes, when international prices
were falling) and there were strong demands
for larger expenditures.
Thus, the government found it difficult to
aim for a very low inflation. In April 1986,
the authorities announced more flexible in-
come policies. The exchange rate and public
sector prices increased by small percentages,
and it was announced that they would be
adjusted periodically. The price freeze was
replaced by a system of administered prices,
concentrating on large firms. Wages would
increase by 8.5 percent in the second quarter;
trade unions and firms were called to discuss
a new set of basic wages which would vali-
date the previous drift.
Contrary to some anticipations, there was
no price shock after the freeze. But the CPI
inflation accelerated to 4.5 percent per month
in the second quarter. The upward drift be-
came general, so that relative prices varied
less than in the previous period. Industrial
real wages increased: negotiations between
unions and firms apparently brought about
2Official estimates of the PSBR (excluding the central
bank but including the revenue from the forced loan)
indicate a fall from 8 percent of the GDP in the first
half of 1985 to around 3 percent between June 1985 and
June 1986.
31t is difficult to distinguish between the effects of
persistent inflationary expectations and insufficient
monetization. Dornbusch (1986) argues that the second
factor was particularly important.
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VOL. 77 NO. 2 STOPPING HIGH INFLA TION 287
significant effective raises. The monetary
expansion now induced a fall in interest
rates, not only in real but also in nominal
terms. The growth in aggregate demand
allowed the rapid industrial recovery to con-
tinue, although firms seemed reluctant to
engage new workers or expand capacity.
In July, the CPI increased by 6.8 percent.
This created great uncertainty. The parallel
("black market") exchange rate suddenly
took off, after having remained almost con-
stant in the previous months. Also, many
firms raised their prices. The government
reacted by tightening monetary and income
policies. Interest rates rebounded and, ap-
parently, industrial sales started to drop; by
contrast, the CPI growth rate fell to around
5 percent in November 1986, down from
almost 9 percent three months before.
IV. Some Concluding Remarks
The results of the program show that fiscal
policies combined with measures to attack
inflationary inertia can deal with a very high
inflation without causing large real costs.
Difficult questions remain regarding the set
of policies that may guide prices along a
relatively stable path in a country with a
long inflationary history, and where distribu-
tive conflicts often lead to strong pressures
on the budget and to inconsistent price-wage
decisions. The heavy foreign debt and de-
clining terms of trade do not make it easier
to reconcile the claims of the various groups.
There is much latent instability, which de-
mands day-to-day policy management. Still,
high inflation and stagnation are more than
occasional problems in Argentina. Longer-
run changes in the working and financing of
the public sector and in the system of eco-
nomic incentives seem necessary to over-
come them. The stabilization program has
stimulated a debate within the country that
may, hopefully, produce some agreement on
such reforms.
REFERENCES
Bresciani-Turroni, Costantino, The Economics of
Inflation, London: Allen and Unwin, 1937.
Dornbusch, Rudiger, "Stopping Hyperinfla-
tion: Lessons from the German Experi-
ence in the 1920s," mimeo., MIT, 1985.
,"Tight Fiscal Policy and Easy Mon-
ey: The Key to Stabilization," mimeo.,
MIT, 1986.
Frenkel, Roberto, Salarios industriales e in-
flacion. El periodo 1976-1982," Desarrollo
Economico, October-December 1984, 95,
387-414.
Heymann, Daniel, Tres ensayos sobre inflacion
y politicas de estabilizacion, Buenos Aires:
CEPAL, 1986.
Leijonhufuud, Axel, "Inflation and Economic
Performance,," in B. Siegel, ed., Money in
Crisis, Cambridge: Ballinger, 1984.
Lopes, Francisco, "Inflacao inercial, hiperin-
fla9ao e desinflacao: notas e conjeturas,"
mimeo., Pontificia Universidade Catolica
do Rio de Janeiro, 1984.
Sargent, Thomas, "The End of Four Big Infla-
tions," in R. Hall, ed., Inflation: Causes
and Effects, Chicago: University of Chi-
cago Press, 1982.
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