Brazilian Gradualism vs Argentinean Shock Treatment

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BRAZILIAN GRADUALISM

VERSUS

ARGENTINEAN SHOCK

TREATMENT

A COMPARISON BETWEEN THE

ANTI-INFLATION STRATEGIES

OF ARGENTINA AND BRAZIL

DURING THE 1980’S

Student name: Frederieke Rooijakkers

Student nr.:

s1392484

Supervisor:

Prof.dr. E. Amann

MA program: International Relations

Date: 21/12/2018

Word count: 14.918

Master’s thesis Leiden University

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Abstract

The objective of this thesis is to identify and explain the similarities and differences between the anti-inflation strategies implemented in Brazil and Argentina, right after these countries returned to democracy in the 1980’s. The comparison between Argentina and Brazil is unique, because these countries share many similarities in their economic histories: they have been isolated from the world economy during most of the 20th_{century, build up high external debts,}

experienced years of heavy military repression and suffered from hyperinflation. Additionally, the first democratic presidents, Alfonsín in Argentina and Sarney in Brazil, faced many challenges. They had to rebuild the state democracy, service the high external debt, and end the deeply-rooted inflation at the same time.

Argentina and Brazil suffered from high inflation levels during most of the 20th

century. Because of the indexation of the economy, the populations of the two countries were able to live hand-in hand with the high inflation rates for decades. This changed in the 1980’s, when inflation targeting became the most important point on the agendas of the new democratic governments. After the launch of the Austral Plan (1985) in Argentina and Cruzado plan in Brazil (1986), inflation and indexation were abolished immediately.

This first objective of this thesis is to explain why the first democratic governments in the 1980’s introduced these shock-treatments in order to end inflation. Additionally, there are several important differences between the heterodox anti-inflation strategies that were introduced by the first democratic governments. In general, Argentina’s Austral Plan seemed more ‘aggressive’ and ‘ambitious’ compared to Brazil’s Cruzado Plan. Therefore, the second purpose of this thesis is to explain where these differences derive from.

The main conclusion is that the choice for a heterodox shock-treatment is connected to the inertial nature of the high inflation rates: the first democratic presidents saw no other option than to implement heterodox inflation-targeting programs right after they took office. Also, this thesis argues that Alfonsín and Sarney’s choice for heterodox shock-treatment is related to the democratic model. Heterodox and orthodox approaches have different effects on society: orthodox inflation-stabilization policies cause economic recession right after the implementation. This is not the case with heterodox shock-treatment, and in order to gain political support, it was more beneficial for these governments to implement heterodox inflation-targeting policies.

Furthermore, this difference can be explained by the fact that the shock-therapies were implemented under different circumstances: the Argentinean economy was in deep economic recession when the Austral plan was implemented in 1985. In contrast, the Brazilian economy was expending at the time of the implementation of the Cruzado plan. Second, in contrast to Brazil, Argentina aimed to restore its relationship with the IMF by introducing aggressive fiscal restrictions.

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List of Tables and Figures

Table Page

1 Case-study topics in chronological order 7

2 Summary of inflation stabilization plans under Sarney 20 3 Summary of inflation stabilization plans under Alfonsín 31 Figure

1 Annual inflation rate (%) in Brazil 19

2 Monthly inflation rate (%) and Inflation Stabilization Programs in Brazil 24 3 Example of a published vignette in an Argentinean newspaper 32 4 Monthly inflation rate (%) in Argentina during the period [1985-1989] 34

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Introduction

“The maid enters the Copacabana Hotel room and replaces the rate card under the table top glass. The room just went up 15 percent, to $84.

It happens all the time.”1

This is a quote from an article from the New York Times written in 1983, when Brazil suffered from hyperinflation and economic recession. The standard of living declined drastically and Brazil was at the brink of hyperinflation. During the last decades of the 20th_{century, many other Latin American countries also suffered from high inflation} rates. Every banknote you keep in your pocket loses its value every day, which has destructive consequences for the purchasing power for the entire society, especially the poor.2

Inflation appears difficult to fight for many of these countries, especially during the 1980’s when the region entered the debt crisis and lost control over their price levels (Dijkstra, 1997, p. 531-532). Inflation limits economic growth, erodes the purchasing power of the poor, causes macroeconomic instability and erodes tax earnings. Because of these destructive consequences, inflation targeting became the primary concern of many Latin American states.

This was also the case in Argentina and Brazil, as the populations of both countries suffered from high inflation levels for decades. The choice to compare the Argentinean and Brazilian case is nothing new, because they have the largest economies in the Southern cone and are the founding members of MERCOSUR (Bolten, 2009, p. 26). In addition, high inflation levels are rooted in their histories, as both countries adopted the Import Substitution Industrialization (ISI) policies for most of the 20th_{century. The goal of this protectionist economic model was to} stimulate the national production of goods instead of importing them. One of the negative side-effects of this growth strategy was that both Argentina and Brazil build up large amounts of external debt. Also, due to the indexation of wages and salaries, the Brazilian and Argentinean public were able to live hand-in hand with high inflation levels during most of the 20th_{century. As soon as the prices went up, the salaries would} increase with the same amount.

1_{https://www.nytimes.com/1983/11/07/business/brazil-battles-inflation-now-at-200-rate.html}_. 2_{Several studies claim that inflation hit the poor relatively more than the rich. This can be explained}

by the fact that the pensions, state subsidies or direct money transfers may not be fully indexed. When the prices keep increasing, their purchasing power declines. See Easterly & Fischer (2001) for a detailed analysis of the effects of inflation on the poor.

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This changed in the 1980’s, when the new democratic governments introduced several shock-treatments in order to end inflation. This thesis focusses on the anti-inflation strategies that were implemented by the first democratic governments in Brazil and Argentina. The research question is:

What are the similarities and differences between the anti-inflation strategies that were implemented by the first democratic governments of Brazil and

Argentina during the 1980’s?

These two countries are good case-study candidates for this thesis, because the two economies are very comparable; they share similar socio-economic histories, the democratization process of the 1980’s happened at the same time and they shifted from inward-oriented economies to neoliberal economies in the 1990’s. However, there are some important differences between the heterodox shock-treatments of Argentina and Brazil. The aim of this thesis is to trace back the causes of these differences.

The new democratic presidents, Raúl Alfonsín (1983) in Argentina and José Sarney (1985) in Brazil, faced many challenges. They wanted to ensure to the public that they rule the country in a democratic way, by stimulating the democratic process and repairing the fragmented political systems after years of military rule. Furthermore, they had to bring an end to the high inflation levels and implement the ‘neoliberal’ paradigms after decades of protectionist economic development models. This was problematic because the national industries were not competitive enough to compete with the international products and industries. The Brazilian and Argentinean governments were forced to run surpluses and increase their revenues, in order to service the large amounts of external debts.

In addition, one of the main challenges of the Brazilian and Argentinean democratic governments was that inflation targeting could not happen without monetary and fiscal restrictions, and these restrictions may have a negative impact on the public. It can be challenging for governments to implement monetary and fiscal restrictions that will lead to the best results in the long term, while maintaining support from the public at the same time. The aim to keep the public satisfied may have an impact on the choice for which anti-inflationary strategy is used.

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There exists a lot of literature on the two stabilization plans that ended hyperinflation, the Convertibility plan (1991) in Argentina, and the Real Plan (1994) in Brazil. However, the inflation-targeting programs that were launched in these countries during the 1980’s are less known. The aim of this thesis is to closely analyze the economic histories and inflation-stabilization policies in Brazil and Argentina, from the 1930’s until the 1980’s, for two reasons. First, the close analysis of the economic history in Argentina and Brazil will provide a better understanding of why these heterodox stabilization plans were created and how they were implemented at that time.

Additionally, these inflation stabilization plans mark a turning point in the social histories of Argentina and Brazil, dominated by protectionist economic models, high inflation rates and indexation of the economy. Tracing back the causal factors of these stabilization plans will provide a better explanation and understanding of why these strict economic measures were implemented in the first place, and why they failed ending inflation. Furthermore, the objective is to explain where the differences in shock-treatment derive from. In order to do so, the decision-making process for the choice of anti-inflation policy is traced back.

The first chapter provides a theoretical framework, in which the most important concepts in this thesis are explained: the causes of high inflation in Latin America, the Import Substitution Industrialization (ISI) development strategy, the debt crisis and deficit financing, interest rates and orthodox and heterodox inflation stabilization programs. Furthermore, chapter two and three consist of two case studies, focusing on the causes of inertial inflation in Brazil and Argentina, the increasing external debt, and the first heterodox inflation-targeting programs launched by Alfonsín and Sarney in the mid 1980’s. Additionally, a brief summary of the inflation stabilization programs that finally ended inflation is provided. Table 1 provides an overview of the main topics of these case-studies, in chronological order.

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Table 1: Case-study topics in chronological order

The structure of chapter four is different from the first three chapters. First, a brief summary of the main causes of inflation is provided to clarify the most important factors of the analyses of the first three chapters. Second, this chapter gives two possible explanations of why the first democratic governments of Argentina and Brazil decided to implement a heterodox shock-treatment. Third, the last part of this chapter provides an explanation of the differences between the heterodox approaches of these countries. Finally, the conclusion of this thesis summarizes the most important arguments that answer the research question.

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Chapter 1 Theoretical Framework

The aim of this chapter is to explain the most relevant concepts of this thesis, that are related to the causes of inflation and inflation-targeting policies in the Latin American region. The first part of this chapter analyses the two main theories on the causes of inflation in the existing literature: the monetarist and the structuralist theory. Also, the principal economic variables from the 1950’s until the 1990’s are analyzed, focusing on the Import Substitution Industrialization (ISI) period and the 1980’s debt crisis. This historical approach is necessary to understand how inflation became imbedded the economic structures in the Latin American region. Also, identifying the causes of inflation is an important step for the choice for which anti-inflation policy should be implemented. This brings us to the second part of this chapter, which consists of a critical overview of the different anti-inflation policies in the existing literature: the heterodox and the orthodox economic policies.

1.1 Causes of high inflation in Latin America

1.1.1 The Monetarist and Structuralist Approach

According to the monetarist view, “inflation is a monetary phenomenon which comes about when the Central Bank increases the money supply in excess of the demand for money. This overly-large increase of the money supply can be caused by monetary financing of the fiscal deficit, or by extending too much credit for the private sector” (Dijkstra, 1997, p. 532). Nonmonetary factors would only affect inflation on the short-run, whereas monetary variables affect the long-run path of inflation rates (Moore, Lewis-Bynoe & Morgan, 2012, p. 826). This monetarist (or orthodox) approach can be summarized in the following formula:

M x V = P x Q

The M represents the quantity of money, V stands for the velocity of money, P equals the price level, and Q represents the national output of Gross Domestic Product3_{(GDP). This formula explains that as soon as the money in circulation} increases, the prices will increase as well. There are different reasons for a bank to decide on increasing the money-supply. For example, when the government is spending more money than it is receiving, the deficit has to be financed. One way to

3_{GDP is the quantitative measure of the total national economic activity. It is the value of everything}

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do this is by printing more money. In this case, inflation can create a vicious circle. When the value of money is declining due to inflation, people prefer to spend more and save less; this drives up the prices. Also, inflation has a negative effect on tax revenues, as the value of tax collection fall (Franko, 2018, p. 112). In response, many Latin American governments printed more money to cover the deficits.

Contradictory to this theory, the structuralists explanation focusses on the structure of the underdeveloped economy as the propagating mechanism for inflation (Franko, 2018, p. 113). They argue that inflation becomes embedded in the economy, and that the liquidity or budget deficits can be the cause inflation. However, the causes of inflation are way more complex, because non-monetary external shocks are involved. For example, the oil and commodity price shocks or the rise in prices of imports play an important role in the increase of inflation (Domaç & Yücel, 2005, p. 145). The government can anticipate on inflation by indexing the prices and wages; as soon as the prices increase, the wages increase with the same amount. This way, inflation can exist for a long period of time, without people suffering from the consequences. The negative side of inflation-indexation is that the economy gets more vulnerable.

Furthermore, several political factors can be the key determinants of inflation. Moore, Lewis-Bynoe & Morgan (2012) explain that The transitioning to a politically repressed regime increases the likelihood of an inflation start by 7%, while elections increase the probability of an inflation start by about 3% (Moore, Lewis-Bynoe & Morgan, 2012, p. 833). This can be explained by the fact that Central Banks pursue an expansionary monetary policy in the period leading up to an election, to increase the party’s chance for reelection. Under democratic rule, there is a public demand for government spending. Also, countries can adopt an accommodative monetary policy that allows wages, salaries and payments to be inflation-indexed (Desai & Olofsgard & Yousef, 2003).

1.1.2 Import Substitution Industrialization

The Import Substitution Industrialization (ISI) Policies were adopted by many developing countries during the 1950’s, in an attempt to diversify the domestic industries away from the primary commodities.4_{Also, state-led strategies had to} reduce poverty and promote infrastructure. According to Felix (1989), “the technologically backward economy tries to accelerate industrial investment primarily

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for the home market through heavy reliance on government manipulation of market prices, barriers to entry and access to imports and finance” (Felix, 1989, p. 1455). In other words, the state plays a very interventionist role in the economy with the goal to create new industries and stimulate domestic production.

In the case of Latin America, a continent with many natural resources and opportunities, the ISI strategy seemed like the right choice in order to stimulate economic development. Many of the industrialization programs were based on natural resources, such as oil and mining, and it was argued that these resources belonged to the nation and should therefore be managed on the public’s behalf (Franko, 2018, p. 64). This way of state intervention can be seen as a pragmatic response to the failure of the free market. Large investments were necessary as whole new infrastructures and industries had to be build op. In many cases, development banks financed these public-sector investments.

The ISI economic model relied on three main tools: active industrial policy, protective international instruments and accommodations fiscal and monetary policy, complemented by a careful program of transnational participation (Franko, 2018, p. 63). First of all, State Owned Enterprises5_{(SOE’s) were created in different industries,} from oil-industries to telecommunications and aircrafts. These state firms had to access public funds for investment, research and developments. Also, they had easier access to international financial markets to borrow for large development projects (Franko, 2018, p. 63). A protectionist economic strategy was carried out, to give the newly-created national industries a chance to develop without the international competition of the multinational firms. In order to achieve this, the government introduced trade restrictions and high import tariffs. Also, national development banks were created mainly to invest in the newly build industries. Large multinational companies were welcomed to provide technology and capital within the ISI model (Franko, 2018, p. 69).

There exist some issues with the way the ISI strategy was implemented and developed in Latin America. One of the main goals of the ISI period was to make sure that the Latin American countries would be less dependent on the external market. In practice, many countries did not see a decline in imports and kept being dependent on the technical knowledge and imports of other countries. Also, the new industries were

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not competitive or efficient enough and the quality of the manufactured products was not as good as the international standards. According to Franko (2018), another negative effect of the ISI strategy is the increase in inequality. increased during the ISI Period because internal demand was severely limited and consumption patterns imitated those of the center elite instead of attending to the needs of the masses (Franko, 2018, p. 73). In short, the economies became very isolated from the rest of the world, while still being dependent on the import products of other countries.

The relation between the ISI and inflation is complex. By implementing the ISI strategy, the nation becomes the source of demand rather than leaving it to the market. Because of the economic isolation, the market was limited in size and there was a lack of competition. This reduces innovation, and a lack of innovation has a negative effect on the quality of the national products. If the prices are high and when there is an overvalued exchange rate, which means that the currency is too high for the state of the economy, this introduces a foreign exchange gap to finance development. Differences in domestic expenditures and revenue in state-owned firms lead to persistent deficits or monetary expansion that results in inflation (Franko, 2018, p. 73).

1.1.3 the Debt Crisis and Deficit Financing

The debt crisis can be considered as one of the key factors that drove high inflation in Latin America. For most countries, the crisis erupted in 1982 and lasted until the 1990’s. In the existing literature, two main arguments are made regarding the origins of the Latin American debt crisis. On the one hand, according to the orthodox view, the domestic factors in Latin American countries (such as the mismanagement of public finances and exchange rates) can be considered as the main factors that provoked the crisis. The unorthodox analysis stressed various international variables, such as interest rate hikes, deteriorating terms of trade and a decline in export volumes associated with the world economic recession (Capraro & Perrotini, 2013, p. 628). This section analyses the three main causes of the 1980 decade of crisis: The oil-shocks during the 1970’s; the changes in the world macro-economy in the beginning of the 1980’s; and the policies in the borrowing countries that had implemented the ISI protectionist model.

According to Dijkstra (1997), one important factor that led to fiscal deficit is the international borrowing and public spending. Up until the 1970’s, government expenditures were mostly financed with tax revenue. Up until this year, the

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government deficits were not extremely high. This had to do with the fact that Latin America was excluded from international borrowing for a long time, except for largely concessional loans from the World Bank (WB), Inter-American Development Bank (IDB) and trade credits (Armendáriz & Larraín, 2017, p. 176). This changed in the 1970’s, as the public expenditure almost doubled and many Latin American countries started to borrow more money from commercial banks. The fiscal expansion and borrowing were reflected in higher deficits, as there were few increases in fiscal revenue (Armendáriz & Larraín, 2017, p. 177-178). Cheap external loans were available, without raising their own taxes: this led to fiscal deficits. Also, when the international borrowing came to an abrupt end, the fiscal deficit had to be financed domestically. This almost always meant increased borrowing from the Central Bank (Dijkstra, 1997, p. 536).

The relation between the 1973 oil shocks and debt accumulation can be explained by supply and demand. In 1973, the OPEC6_{countries proclaimed an} embargo on oil exports. The main reason behind this was to penalize the United States and other countries that supported the Israel conflict. The oil prices increased from 1973 until 1979, and the surpluses that were created in the oil-producing countries were called petrodollars. According to Franko (2018), these petrodollars were deposited or ‘invested’ in international commercial banks, (Franko, 2018, p. 177-178). For non-oil-exporting countries, the major increase caused them to borrow more money to cover the high oil-prices which resulted in an increase in deficits. Also, the lower demand for primary products and a fall in trade in the non-oil exporting developing countries caused a balance of payment crisis, as developing countries could still borrow money in order to finance the trade deficit.

It is very hard to tackle inflation once it starts, because there are a few mechanisms that sustain or even worsen the price increases. First of all, if taxes are paid in fixed nominal terms, their value reduces. According to Dijkstra (1997), the government can choose to finance part of the deficit from inflation tax. But the higher the inflation, the lower the real value of money. The value of real cash balances diminishes and the need for more inflationary financing grows (Dijkstra, 1997, p. 536). Another common phenomenon is called ‘dollarization’, which means that the population start to use foreign currency. This fuels inflation because when prices are

6_{OPEC stands for ‘Organization of Petroleum Exporting Countries’. This intergovernmental organization has 15 members. In total, these}

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set in dollars, a depreciation of the currency leads automatically to price increases (Dijkstra, 1997, p. 536). These phenomena could eventually cause hyperinflation.

1.2 Anti-inflation targeting policies

1.2.1 Orthodox and Heterodox approaches

The inflation stabilization programs can be divided into two categories: the orthodox money-based stabilization approach and the heterodox exchange-rate stabilization approach. The orthodox approach includes restrictions in the monetary and fiscal policy, which was favored by the IMF. According to Roett (2011), these restrictions include “currency devaluation, reduction of import controls, credit restrictions and a reduction of government spending, higher prices for public utilities, freeing of prices, wage repression, reduction of public employment and these policies usually produce a slowdown of economic growth” (Roett, 2011, p. 254). In other words, this stabilization program requires economic sacrifice from the public and reduces the living standards of the citizens. Also, the liberalization of imports should lead to internal stabilization, as it reduces import prices (Dijkstra, 1997, p. 539).

After the implementation of this strategy, it is very likely that the country will experience a period of economic recession with a recovery of economic activity later on. In addition, the fastest way to achieve the IMF goals was to cut the budget for social spending. This was a good option for some countries because military governments could do so without a fear of rebuke (Roett, 2011, p. 155). However, this was a different story for fledgling democracies as they also need the support of the public.

In contrast, the heterodox stabilization policy controls the prices and wages for a certain period of time. This way, the inflation process is controlled and the tax-revenues will increase. Also, the period of controls gives the government time to introduce tax reforms in order to increase the tax revenue (Dijkstra, 1997, p. 540). This approach focusses on income policies, fixed import coefficients and slow-moving export volume responses to devaluation (Mann & Pastor, 1989)

1.2.2 Interest rates as nominal anchor

Another approach is the use of the exchange rate as ‘nominal anchor’. The exchange rate is the price of one currency in terms of another. This rate can be fixed, flexible or crawling pegs. In today’s economies, many countries adopt a floating exchange regime. This means that the price of foreign exchange is adjustable, and that the price of the currency is determined by the demand for the country’s goods (Franko, 2018, p. 67).

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The big difference between floating exchange rates and fixed exchange rates is that the fixed exchange rate promotes price stability, whereas the adjustable exchange rate may cause inflation. In the case of anti-inflation policy, the exchange rate is fixed in order to reduce domestic money supply which causes the prices of non-tradable goods to go down. This way, the exchange rate functions as a stabilizer. However, this can only happen under certain conditions. According to Dijkstra (1997), Foreign reserves must be available, there has to be monetary contractions, and the private sector must believe that the government will allow the monetary contraction to occur, otherwise it will continue to raise prices (Dijkstra, 1997, p. 541). This means that the psychological aspect plays an important role in inflation-targeting policies: as soon as the public and the private sector have confidence in the economy and believe that the prices will go down, this will have a positive effect on the inflation-rate.

In addition, Gaffeo & Canzian (2011) argue that “the general attitude towards inflation and output dynamics, and the mechanisms by which the public forms expectation about them, play a key role in defining the effectiveness of actual macroeconomic stabilization policies, especially as regards the conduct of monetary policy” (Gaffeo & Canzian, 2011, p. 660). This can be explained by the interest rates that are set by the central banks and the ‘Taylor principle’. The ‘Taylor principle’ analyses the relationship between the interest rates and the macro-economic variables. When the central bank decides to adopt the Taylor principle, the nominal interest rate should rise enough to ensure that also the real rate increases (Gaffeo & Canzian, 2011, p. 660). The difference between the nominal interest rate and the real interest rate is that the real interest rate takes the inflation rate into account. For example, when the nominal interest rate in one year is 5% and the inflation rate is 3%, than the real rate is 2%. However, when the nominal rate is 5% and the inflation rate is 7%, the purchasing power will erode with 2% that year. If the Central Bank sets the nominal rate too low, this will lead to an excess in demand and the inflation will be higher than expected (Caffeo & Canzian, 2011, p. 660).

Concluding notes

The purpose of this chapter was to provide an explanation of the most important concepts for this thesis, related to inflation targeting in Latin America. The Latin American economies have been vulnerable to external shocks. For example, the increase in world commodity prices in the 1970’s raised capital inflows. This, together

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with the external debt explosion from petrodollars, enabled Latin American governments to finance large public deficits. The monetarization of the high capital inflows to finance large public deficits can be seen as the major cause of the increased inflation rates. Also, the economic expectations and the confidence of the public and the private sector play an important role in inflation stabilization, and these expectations can be shaped by the monetary policy.

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Chapter 2 Inflation Stabilization in Brazil

This chapter has three main objectives; to put the causes of the high inflation rates in Brazil in historical perspective, to critically analyze the main reasons why the first anti-inflationary plans failed, and to describe the main aspects of the Real Plan, which ended hyperinflation in the 1990’s. The analysis of these inflation related topics is important, in order to make a good comparison to Argentina’s anti-inflation strategies in the same period.

2.1 Historical Context

2.1.1 ISI Growth Strategy and Hyperinflation

In Brazil, the Import Substitution Industrialization strategy was implemented from the 1930’s until the 1980’s, as a pragmatic solution for the economic problems that were created by the collapse of the world market in 1929. In general, during the first decades after the implementation, the ISI development strategy seemed like a great success: at the end of the 1970’s, there was hardly any doubt that Brazil would close the gap separating it from the OECD countries, just like South Korea and Taiwan did in the 1980’s (Meyer-Stamer, 1997, p. 35-36). However, a severe economic crisis erupted in the 1980’s. These national industries were not efficient nor competitive enough compared the industries and products of other countries.

Scholars both favoring and opposing the ISI model agree that the ISI growth strategy had some weaknesses. The first weakness is that ISI did not lead to a reduction of external influences. Brazil kept on being dependent on the import of certain components to build their products. For example, instead of importing washing machines and cars from other countries, Brazil wanted to build new industries to make these products themselves. However, they still needed technologic knowledge and different components from other countries in order to make their products.

Second, in many cases, the ISI led to an overvalued exchange rate. High import rates were used to block imports and stimulate national production. At the same time, capital goods were necessary for the industrial production of these newly-build industries. These crucial imports were made cheaper for industrialists, and the exporters’ earnings in national currency were reduced (Lyne, 2015, p. 85). The lack of competitiveness on the part of industry found expression in the low level of exports of manufactured goods. In 1949, the Brazilian industry’s export share was no more than

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2.3%. Thus, the industrialization process remained dependent on exports of primary goods, especially coffee (Meyer-Stramer, 1997, p. 38). Slowly, the economy became more isolated and more vulnerable to inflation. The budget was balanced by issuing new money, and this was one of the most important causes of inflation (p. 38).

In addition, the rising of government spending was not financed by tax revenue, but with the aid of credits provided by Brazil’s largest state-owned bank: Banco do Brazil (Meyer-Stramer, 1997, p. 40). According to Da Fonseca (1998), the government projects and programs were devised without a lot of concern as to how they would be financed. For example, in terms of monetary policy, the Central Bank was free to provide loans beyond its deposits, since any shortage of currency was provided by the Central Bank. these credits were neither serviced nor paid back, and the budget deficit kept on increasing, which led to increases in money supply (Da Fonseca, 1998, p. 622).

Overall, the ISI growth strategy can be interpreted as the basis for of Brazil’s major economic problems, especially during the 1980’s when Brazil entered the neo-liberal area. The Import-substitution model encouraged inefficiency in the Brazilian industries, the domestic industries were known for high prices, low quality and out-of-date technology.

2.1.2 Military Reforms and the Return to Democracy

The military took office in 1964, primarily because United States’ fear of communism in the Latin American region. Castelo Branco became the first president of the military government, and General Artur Costa e Silva appointed himself as ‘war minister’ of the new government (Skidmore, 1997, p. 19). In the case of Brazil, this military intervention was seen as a temporary situation to forestall the communist treat and reestablish stability. However, the military stayed in power for twenty-one years, which can be explained by the fact that the military regime received a lot of support from the Brazilian public. Many Brazilians tolerated the repression, but only if their living standards would improve.

The military regime implemented several economic reforms that affected the Brazilian foreign-trade policy. For example, the taxation system was reformed, in order to increase tax revenues. In addition, various nontariff trade barriers were reduced, exports were stimulated with direct subsidies and subsidized export credits (Meyer-Stramer, 1997, p. 42). These economic reforms had a positive effect on the

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Brazilian economy. In 1973, the Brazilian economy was at its peak, after 6 years of economic growth and decreasing inflation levels (Grinberg, 2008).

The economist Dr. A. Delfim Netto was the Brazilian minister of finance during the time of unprecedented economic growth. He was nicknamed ‘the architect of the Brazilian miracle’, and he used to be a professor at the University of Sao Paulo. However, the economic miracle did not last on the long-term, because Brazil was still dependent on imports and was very vulnerable to external shocks. During the 70’s, the foreign debt accumulated by borrowing large amounts of cheap petrodollars. Further, the external oil shock of 1979 and the suspension of new external financing led to an increased foreign debt (M.A. Szybisz & L. Szybisz, 2017, p. 4).

After ten years of heavy military repression, the so called ‘decompression period’ started. The military started to lose its credibility when the prices increased and the 80’s crisis erupted. Now, the Brazilian citizens were exposed to heavy military repression, without experiencing any economic benefits or stabilization. Instead, by 1982, debt service was equal to 83% of export earnings (M.A. Szybisz & L. Szybisz, 2017, p. 4). Also, Brazil was obligated to spend much of its foreign exchange on servicing the foreign debt (Skidmore, 1999, p. 194). In 1980, the newspaper the ‘Time’ stated the following:

“Keeping company with such indigent nations as Zaire, Peru and Bangladesh, Brazil has earned the dismal distinction of being the developing country that has plunged most deeply into deficit. At the moment, it owes the astonishing total of more than $50 billion, mainly to international banks.”7

The opposition to the military regime started to rise, with the goal to step away from the ISI strategy, implement a more liberal economic model and return to democracy. The military initiated a process of ‘abertura’, which meant the opening of the economy and the transition to democratization. In 1985, after 21 years of military rule, the Electoral College appointed a civilian president. This way, the military wanted to make sure that the candidate was capable of facing Brazil’s severe economic and political problems. Tancredo Neves seemed like the right politician to do this, because he had a lot of support and confidence from the Brazilian public. However, he passed away unexpectedly, right before he was supposed to take office. José Sarney was appointed as the first democratic president instead.

7_{Retrieved from the Academic Search Premier;}_{A Mountain Of Debt In Brazil International bankers} are hooked by the biggest borrower. Time, 0040781X, 8/25/1980, Vol. 116, Issue 8.

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2.2 Failed Inflation-stabilization Programs

2.2.1 Inflation stabilization under J Sarney

J. Sarney was from the political party PMDB, the ‘Partido do Moviment Demcrático Brasileiro’, the opposition party of the military regime. The main problem was that Sarney was not well prepared to become Brazil’s president, when Brazil was in a state of deep economic and political crisis. Also, the moment he took office, the inflation levels were already high, due to the old practice of monetary financing of budget deficits. Sarney had limited means to resist spending pressure from the congress, which resulted in inflation (M.A. Szybisz & L. Szybisz, 2017, p. 5). In addition, Roett (2011) argues that Sarney was not very popular with the public compared to Neves, in a time where a well-prepared president with a lot of support from the public was needed to repair the Brazilian economy. Figure 1 gives an overview of the annual inflation rates in Brazil during the period [1945-1993]. The period in which Sarney was the Brazilian president [1985-1990] is surrounded in blue. Something that stands out in this graph is that inflation remained a problem throughout Sarney’s entire presidency. Also, when Sarney left office in 1990, inflation rates were still high.

Several stabilization plans were carried out from 1986 until 1991, which centered on wage and price freezes (Da Fonseca, 1998, p. 626). However, instead of ending inflation, the Sarney administration pushed price increases to hyperinflationary levels.

Figure 1: Annual inflation rate (%) in Brazil [1945-1993]

Source: Bolten, A. (2009). Pegs, Politics and Petrification: Exchange Rate Policy in Argentina and Brazil since

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Table 2 provides an overview of all inflation-stabilization plans that were implemented during the Sarney administration:

During these years, Sarney had to get the high inflation levels under control, stimulate economic growth in order to reduce poverty, and rebuild the Brazilian democracy. Further, he had to make sure that any proposal that originated from the IMF was avoided. It is challenging to accomplish all of these goals at the same time, because any initiative in the direction of reducing the deficit and promoting monetary discipline met strong opposition (Da Fonseca, 1998, p. 626).

Furthermore, the challenges of Sarney’s cabinet are connected to the authoritarian constitution that was implemented by the military in the 1960’s. This constitution was still the law of hand, and Sarney had to ensure the public that he would rule the country in a democratic way. Second, the promises Sarney made during his campaign were not always executed. This can be explained by the fact that the first democratic government had been selected by Neves. Sarney inherited the same cabinet, which was deeply divided between the orthodox Francisco Dornelles and the heterodox stabilization proposals by Sayad (Bolten, 2009, p. 177-178). This division caused complications in the communication and corporation in the cabinet.

2.2.2 the Cruzado Plan

Before the implementation of the Cruzado plan in March 1986, the Argentinean experience with the heterodox Austral plan was widely debated in the Brazilian academic publications, newspaper articles and business circles. Important historical figures, such as Delfim Netto, admitted that it was time for the ‘younger generation’ and accepted their heterodox ideas (Neiburg, 2006, p. 623-624). It is important to mention that the Department of Economics at the Catholic University of Rio de Janeiro (PUC) played a prominent role during the preparations for the stabilization shock treatments. In the year 1980, the PUC turned into a think-thank for developing and publicizing new stabilization theories and plans, the first being the Cruzado Plan (Neiburg, 2006, p. 620). However, big names of previous generations that supported

Table 2: Summary of inflation stabilization plans under Sarney [1986-1989]

Cruzado Plan March 1986

Cruzado II Plan November 1986

Bresser Plan June 1987

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the ‘developmentalist’ economic model were also able to spread their message and kept good relationships with the Cruzado Plan officials.

In 1986, the Sarney government implemented the first heterodox stabilization plan, ‘Plano Cruzado’. The administrative measures of the plan were the de-indexation of the economy, the introduction of a new currency ‘the Cruzado’, and the convention of the debt, rent, wages, school tuitions, and mortgage payments to the Cruzado via formulas that guaranteed the decomposition of the real price of the last six months (Pereira, 1987, p. 1036).

The first few months after the implementation, the plan appeared to be a success. Inflation fell drastically, there was a consumer boom, and labor shortages caused further wage increases (Skidmore, 1999, p. 193). At this stage, the role of the exchange rate was from less importance as the plan mainly relied on price freezes and de-indexation. “The exchange rate was treated like any other indexed price, which had to be de-indexed and then frozen indefinitely for the heterodox shock to succeed” (Bolten, 2009, p. 180).

The success of the plan lasted until November 1986. Capital flights were rising, and the shortages in goods triggered illegal pricing practices, which led to the re-emergence of inflation (Bolten, 2009, p. 180). In December, inflation already started to accelerate, and the exchange rate became overvalued as imports were favored and exports discouraged (Skidmore, 1999, p. 193). Also, Sarney’s popularity started to fall and many started doubting his anti-inflation strategy. They feared that as soon as the government decided to end the period of fixed prices, inflation would come back. The public budget deficit was still being balanced by printing more money, which is one of the main reasons why the Cruzado Plan failed after the prize-freezes were removed. In November of the same year, Sarney introduced new economic measures, trying to stabilize the economy. This was also called the ‘Cruzado II plan’, and the indirect taxes were increased, the frozen public utility prices were adjusted upward and the exchange-rate peg was abandoned (Bolten, 2009, p. 181). However, the Cruzado II plan also failed and both inflation and indexation returned.

2.2.3 The Bresser Plan and the Summer plan

In 1987, Sarney introduced another heterodox stabilization initiative, which was called the ‘Bresser plan’. The main goal of this plan was slightly different compared to the previous Cruzado Plans: the aim was to prevent hyperinflation rather than achieving substantial disinflation by combining heterodox elements (Bolten, 2009, p. 182). In

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order to do so, another price-freeze and fiscal adjustments were implemented, as a means to end inflation. However, soon after the implementation, it became clear that this plan was no solution to the severe economic problems of Brazil.

Before launching the plan, Sarney appointed Luis Carlos Bresser Pereira as the new Brazilian minister of finance. Bresser Pereira was a former student of A. Delfim Netto, who used to be a member of the Brazilian military regime (Neiburg, 2006, p. 622). It is remarkable that these heterodox theories had many focal centers of production in Brazil, for example the School of Business Administrations of São Paolo (EAESP) and the PUC. Bresser Pereira also used to be a professor at the EAESP, and he was a former student of one of the ministers of finance during the military regime: A. Delfim Netto (Neiburg, 2006, p. 622).

In response to the failure of the Bresser plan, the government introduced a ‘life-raft’, the unidade de referencia de precos (URP). Flynn (1989) argues that the main purpose of the URP was to readjust and regulate wages in relation to price rises. These rises would happen every three months, and by 1988, rises happened every month in the private sector. The problems started when the wage indexing was only two-third of the monthly inflation rate. In addition, many workers organized strikes in response to the returning high inflation rates.

Additionally, the ‘Black Beans and Rice plan’ was introduced in 1988, followed by the ‘Summer plan’ in 1989. By this year, the orthodox part of the plan was getting more support. During the Cruzado Plan, fiscal and monetary policies were passive. However, the idea of the Summer plan was to combat inflation by controlling the public deficit, by controlling expenditures and increasing revenues, for example by privatizing public-owned assets and wages (García, Guillén & Kehoe, 2014, p. 16). Another aspect of this plan that was different from the previous heterodox plans, is that it aimed to reduce subsidies, closing public firms, and firing excessive public employees (García, Guillén & Kehoe, 2014, p. 16). In the end, the Sarney government lacked the political power and support to implement all features of the Summer plan with success.

In sum, the Sarney government was too weak to improve Brazil’s revenue situation, implement a price policy and to reduce the high levels of subsidization (Meyer-Stramer, 1997, p. 107). After less than three years, the Sarney government had had three different ministers of finance, four presidents of the Central Bank and five different economic reform projects (Flynn, 1989). He faced many economic and

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political problems when he took office: the foreign debt crisis, which was the outcome of the 1970’s ‘debt-led’ growth, high inflation rates and the recovery of the democracy after heavy years of military repression. Because of the failure of the different stabilization plans, the public lost confidence in the ability of the Sarney government to end inflation.

2.2.4 Inflation targeting under Collor de Mello

During the 1989 elections, the Brazilian public voted for a new president that was not linked to the Sarney government. Fernando Collor de Mello won the elections from Luis Inácio Lula, and the main objectives of his administration were to combat inflation and to implement structural reforms to create economic development. According to Meyer-Stamer (1997), he introduced the following core elements in order to achieve these goals:

1. He froze the saving accounts in order to stop the overexpansion of money supply. In total, 70-80% of Brazil’s total liquidity was frozen for 18 months.

2. A balanced state budget was introduced (for example by privatizing state-owned firms), to eliminate high inflation rates.

3. Further, he adopted a floating exchange rate system.

4. Finally, he froze prices and wages and he introduced high taxations on all transactions.

By implementing these economic policies, Collor de Mello aimed to strengthen the Brazilian market mechanisms (Meyer-Stamer, 1997, p. 109). However, the real effect of his anti-inflationary plans were destructive for the Brazilian economic activity. By 1990, annual inflation even peaked at 2950% (M.A. Szybisz & L. Szybisz, 2017, p. 5). Figure 2 provides a graph of the monthly inflation rates per month, from January 1986 until January 1999.

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If you compare the four anti-inflation strategies which have been analyzed so far (Cruzado plan, Bresser plan, Summer plan, and the Collor plan), it becomes clear that most of these programs contained a heterodox-shock element. Most of the anti-inflation strategies contained an immediate price freeze, abolished price indexation, and introduced a new currency. In addition, something that stands out in figure 2 is that the Real Plan (1994) finally ended inflation. The next section analyses how the Real plan managed to bring back confidence in the Brazilian economy and restore the high inflation-levels.

2.3 The end of inflation: the Real Plan

The year 1994 marks a turning point in Brazilian history: this year, the anti-inflation Real plan was introduced, as an outcome of many years of research by the same group of academics that designed the heterodox shock treatment. Designed by the minister of finance Henrique Cardoso, the real plan was based on the “de-indexation of the Brazilian economy and the liberalization of the trade and capital accounts of the balance of payments” (Saad-Filho & Mollo, 2002, p. 123). In other words, the real plan stopped the government from raising prices and linked the exchange rate of the new currency to the US dollar. The new plan was very successful, as it brought an end to high inflation without limiting economic growth.

Figure 2: Monthly inflation rate (%) and Inflation Stabilization Programs in Brazil.

Source: Saad-Filho, A. & Mollo, M. (2002). Inflation and stabilization in Brazil: A political

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In the first stage of the Real plan, the government wanted to take back over their expenditures. In order to do this, the URV (unidade real de valor) was introduced: a parallel currency to the Cruzeiro real, but without inherited inflation. In addition, this new currency was linked to the US dollar, in order to create confidence by the public. The URV can be described as a transitory monetary system, in order to change the psychology of the population. This confidence-boost was needed, as the Brazilian population became skeptical about the government’s ability to target inflation after the failure of several anti-inflation plans.

Consequently, most commodities had two prices: one that was fixed in the URV, and one that was determined daily in the domestic currency. The URV helped to prevent the decline of real wages in spite of high inflation in the old currency; stability in these prices provided the anchor for the emergence of a price system (Saad-Filho & Mollo, 2002, p. 124). After the establishment of the new – more stable- price system, the currency was officially changed to the Real. Short after the implementation of the Real, the value of the currency was raised to around R$0.85 per dollar. This way, the dollar became the nominal anchor and was even overvalued.8_{Furthermore, imports} became cheaper and limited the room for domestic producers to raise prices (M.A.

Szybisz & L. Szybisz, 2017, p. 5). Also, the policy-makers set interest rates at 8% per month. These high interest rates, together with financial liberalization, attracted capital flows (Saad-Filho & Mollo, 2002, p. 123).

Due to the successes of the Real plan, Cardoso decided to run for president in the 1995 elections. He won the elections, and one of the most important part of his policies was to permit strong economic growth, while lowering the annual inflation rate. This was very successful, as the inflation rate lowered from nearly 1,000 percent in 1994 to nearly zero in 1998.9_{In the end, the government received the support from} the IMF to allow the exchange rate to float10_{, while keeping inflation under control at} the same time.

8_{During this period, a fixed exchange rate was used. In order to maintain the exchange rate, the own}

currency is bought or sold.

9_{Retrieved from}_{https://www.britannica.com/place/Brazil/Brazil-since-1990#ref951812}

10_{By adopting a floating exchange rate, the currency price is set based on supply and demand}

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Concluding notes

Up until the 1980’s, the Brazilian economy became isolated and vulnerable to external shocks, mainly because of the Import Substitution development strategy. At the same time, inflation became embedded in the Brazilian economy at the same time due to price indexation. José Sarney became the first democratic president after 21 years of military rule. Before the Cruzado Plan was launched in 1986, the possibility of a heterodox stabilization plan was widely debated in the Brazilian newspapers and articles. However, after all inflation-stabilization plans that were launched by Sarney failed, the Brazilian public lost confidence in his ability to stabilize the economy. The economic measures that were taken by his successor Collor de Mello damaged the Brazilian economy even further. Additionally, throughout the second half of the 20th century, the generations of economists that fulfilled a position in the ministry of Economy are connected, even though their ideas were different (military regime vs democracy; heterodox vs orthodox approach). The next chapter analyses the inflation-targeting policies of Argentina during the same period.

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Chapter 3:

Inflation Stabilization in Argentina

From the 1950’s until the 1990s, the Argentinean economy was dominated by unstable growth and rising inflation. After several periods of ‘Peronist’ governments, bloody dictatorships, and failed inflation stabilization plans, the introduction of the Convertibility plan 1991 finally brought an end to hyperinflation. The objectives of this chapter are the same as the previous chapter. First, the causes of high chronic inflation rates and price indexation are analyzed. In addition, the second section provides a brief description of the failed inflation-stabilization policies. Finally, the main aspects of the Convertibility plan are analyzed, which ended hyperinflation in 1991.

3.1 Historical Context

3.1.1 ISI Growth Strategy and Hyperinflation

From 1945 until 1990, “the Argentinian economy went through a long period of slow and unstable growth while suffering rampant inflation” (Cavallo & Cavallo Runde, 2017, p. 107). In 1946, Peronism11_{emerged as the dominant political representative of} the working and lower classes. Also, the Import Substitution Industrialization growth strategy was implemented and the state took control over the economy. The government implemented high taxations on import products and promoted industrial self-sufficiency. This way, the economy became isolated from the global market, as foreign imports got replaced by domestic production. At the same time, Perón raised government expenditures. In the beginning of the ISI period, the government was able to finance its fiscal deficits with past savings. However, eventually the deficits were paid for with monetary expansion (Cavallo & Cavallo Runde, 2017, p. 108). This way, inflation became embedded in the Argentinian economy just like in Brazil. Between 1956 and 1972, several governments tried to engage in the world economy, but they failed to reduce the high inflation rates and to end the anti-export bias.

The 1970’s mark a turbulent period in the Argentinian history: from the mid 1970’s onwards, Argentina entered a spiral of elevated inflation and relative stagnation. The return of Peronism in 1973 had a large impact on the Argentinean economy. J. Perón initiated his third presidential term in 1973 and he implied

11_{‘Peronism’ is a political movement based on three main pillars: social justice, economic}

independence and political sovereignty. After the creation of Peronism in 1946, many ‘peronist’ presidents won the elections in Argentina, and they implemented policies that are based on these pillars.

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economic policies that were similar to those in 1945 during the ISI period. He taxed the agricultural prices, promoted manufacturing and domestic services, and financed fiscal deficits with monetary expansion (Cavallo & Cavallo Runde, 2017, p. 108). Also, a fixed exchange-rate was established, wages and salaries increased and different expansionary fiscal and monetary policies were implemented (Díaz-Bonilla & Schamis, 2016, p. 76).

After J. Perón passed away in 1974, his wife Isabel Perón took his place. The Argentinean economy entered a recession in the same year and the opposition of the Peronist government started to rise. This affected the national security, economic organization and political leadership. Since the return to power of the Peronist government, it had lost $1 billion US dollars in reserves, discouraged private investment and inflation accelerated drastically.12_{Without Perón’s charismatic} leadership to bind together the movement’s disparate parts, “Peronism became an arena for praetorian struggles among leftist guerrillas, paramilitary groups and unions” (Levitsky, 2003, p. 48).

Things got worse in 1975, when Argentina suffered from an economic crisis. Díaz-Bonilla & Schamis (2016) argue that “the Peronist government tried to rekindle economic growth through simulative fiscal and monetary policies, but this only fueled inflation, which made the real exchange rate decline even further” (Díaz-Bonilla & Schamis, 2016, p. 76). The inflation rates increased to over 100% a year, and all the attempts to introduce partial economic reforms to reverse the stagnation and high inflation rates failed (Cavallo & Cavallo Runde, 2017, p. 108). The government not only suffered from economic instability and high inflation rates, but also from escalating violence by guerrilla groups and paramilitary forces. In 1976, one year after the eruption of the severe economic and political crisis, Dictator Jorge Rafael Videla overthrew Isabel Perón.

3.1.2 Military Reforms and Return to Democracy

The military coup was the beginning of a dark period for many Argentinian citizens, as Videla ruled with an iron fist. During his dictatorship, many Argentinian citizens disappeared, and Finchelstein (2014) argues that “the military juntas systematically kidnapped, tortured, and killed between 10,000 and 30,000 Argentine citizens, as well as people of other European and Latin American nationalities” (Finchelstein, 2014, p.

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122-123). The key elements of the junta were based on the ideas of anti-Semitism and anti-communism. Even though Videla’s junta violated human rights, killed citizens and took away the rights of the population, he also enjoyed widespread civilian support. Some even argue that his dictatorship was as popular as Perón’s regime had been during the 1940’s and 1950’s (Finchelstein, 2014, p. 123).

Argentina already had macroeconomic, institutional and political problems before the military came to power. Martínez Hoz was appointed as Minister of the economy, with the mandate to restore macroeconomic order and break international isolation that was mainly inherited from it ISI growth strategy in the past (García Heras, 2018, p. 219). De Hoz was an opponent of Peronism and state intervention in the economy, and he implemented a free-market economic model. In addition, the appointed economic team was liberal-oriented and mainly focused on the improvement of the relations with the IMF, the looming foreign debt default, and the coherent economic program (García Heras, 2018, p. 219).

The new economic policies of the military regime were ambitions. The liberal economic team wanted to “reduce inflation, improve government finances and the balance of payments, recover Argentina’s exports and markets, rebuild and modernize basic infrastructure and services, and eliminate macroeconomic distortions” (García Heras, 2018, p. 220).

The anti-inflationary program succeeded in reducing inflation on the short-term: inflation went down from 175 percent in 1978 to 100 percent in 1980. Further, according to Bolten (2009), the new model focused on the agricultural and primary commodity exports, financial sector growth by pre-setting exchange rates and a passive monetary policy. However, the market-driven rhetoric diverged from government practices, because they failed to control spending. This resulted in fiscal imbalances, and the promise of the government to target inflation remained unfulfilled as the recessionary economy experiences inflation of 130% in 1978 (Díaz-Bonilla & Schamis, 2016, p. 78).

However, the new policies also led to severe economic problems. After 1978, de Hoz’ position weakened due to industrial recession, rising unemployment, and a sharp increase in the balance of payments deficit and high interest rates. It was impossible to end inflation through orthodox stabilization programs, which is why he sought a way to reduce inflation in a ‘less painful’ way. The economic team decided to implement a foreign exchange policy, taking inspiration from the economic model of

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Chile that was implemented around the same time. This program was designed with the help of the Chicago Boys13_{, in order to see quick results on the inflation front after} Hoz’ failure to bring down inflation (Veigel & James, 2005, p. 135).

The plan consisted of two parts. First, there was a schedule of preannounced corrections of the free exchange rate between the peso and US dollar (Garcia Heras, 2018, p. 227). Second, tariffs on imports were reduced gradually. The problem with these measures was that Argentina had been isolated from international competition for a long period. In addition, in order for a pre-determined exchange rate program to work, the government needs to control the fiscal deficit and money creation. The government failed to do so and domestic inflation continued to exceed the international inflation (Veigel & James, 2005, p. 137-138).

This led to an overvaluation of the exchange rate. Real economic problems started to rise when the lack of competitiveness of the Argentinean companies led to a growing current account deficit, which had to be financed with foreign borrowing. However, as soon as the investors start to lose confidence and stop investing, the Central Bank would be able to defend the overvalued exchange rate, as long as international reserves lasted (Veigel & James, 2005, p. 139). If not, this could lead to a currency crisis.

High inflation was a permanent problem for the economic team of the military government (Díaz-Bonilla & Schamis, 2016, p. 79). Ending inflation had been one of the main rationales for justifying the 1976 coup. By the end of 1978, inflation continued at a rate of 150% a year, and the economy was in recession. The military junta started to lose its credibility after Argentina lost the Falkland war to England. At the same time, Argentina faced many problems with the banking and financial crisis of the 1980’s, marked by macroeconomic instability and high inflation rates. Two of Argentina’s largest banks collapsed, inflation was averaging 20 percent per month, and exchange rates fluctuated dramatically (Tanner & Sanguinetti, 1997, p. 529).

In addition, Argentina accumulated an enormous debt in foreign currency between 1976 and 1981, due to capital flight, devaluations of the peso, an overheating in the exchange market, and foreign exchange losses (Garcia Heras, 2018. p. 233). According to Frenkel (1987), this increase in servicing external loans effected the

13_{The ‘Chicago Boys’ were Chilean economist, trained at the Department of Economics at the University}

of Chicago. In Chile, the reforms implemented by the Chicago Boys consisted of three main objectives: stabilize inflation, implement a free-market economy and privatize state-owned companies.

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functioning of the economy, especially on the savings and investment capacity. Because foreign savings decreased, the economy was forced to generate surpluses. Because of this, both public and private expenditure collapsed (Frenkel, 1987, p. 310). When General Reynaldo Bignone came to power in 1982, he inherited an annual inflation rate of 140%, a foreign debt of $35 billion US dollars, and a severe devaluation of the Argentinean peso (Conklin & Davidson, 1986, p. 239). In 1982, it was decided that much of this debt would have to be financed with the help of the IMF. One year later, the Argentinean government and the IMF agreed to a fifteen-month loan in support of an economic recovery program to reduce inflation and improve the balance of payments (Conklin & Davidson, 1986, p. 240).

3.2 Failed Inflation-stabilization Programs

“economía de guerra (war economy), which required an adjustment that would be hard and that would demand a concerted effort from everyone in order to win the

battle against inflation” (Bolten, 2009, p. 86).

These are the words of democratic president Raúl Alfonsín in 1985, during his speech on the Plaza de Mayo. He became the first Argentinean democratic president after years of heavy military repression. The most important point on his political agenda was to stabilize the Argentinian economy and promote democracy. In order to do this, he abolished indexation and inflation, and made sure that the power of the military was limited by cutting their budgets. His attempts trying to end inflation are closely related to the stabilization policies of the IMF, because Alfonsín needed loans from the IMF and the World Banks to keep servicing Argentina’s massive external debt. As soon as the IMF and World Bank decided not to suspend further loans, Alfonsín implemented a shock approach trying to bring an end to inflation out of urgency. All failed inflation-stabilization programs that were designed by the ‘Austral-team’ are summarized in table 3:

The Austral Plan June 1985

The Austral Plan II October 1987

The Primavera Plan August 1988

Brazilian Gradualism vs Argentinean Shock Treatment