Stopping three big inflations (Argentina, Brazil, and Peru)

Much existing literature fails to recognize that high inflation (annual rates in three digits) is a distinctly different phenomenon from moderate inflation and hyperinflation. The failure to understand the specific features of the inflation process in the chronic high inflation economies has many times led to a wrong diagnosis of the underlying reasons for changes in inflation in those economies, and the policies needed to stabilize prices in those countries. This lack of understanding extends to the interpretations of the recent hyperinflation in some economies. Argentina, Brazil, and Peru in the 1980s were certainly high-inflation countries. The recent episodes of hyperinflation in these countries were not isolated - instead, they were the culmination of an unstable process, in which inflation crept up gradually for many years before accelerating explosively. These episodes were important because they helpedto dispel the myth that it is possible to maintain a stable high rate of inflation on a long-term basis without harmful effects on growth. The causes of the new hyperinflations were not as clear as in the classical episodes, as they originated from a combination of fiscal and nonfiscal factors. The chronic fiscal imbalances eventually became an insurmountable obstacle, and inflation moved away from the fragile high inflation equilibrium into hyperinflation. The interesting feature of the new episodes (especially in Argentina and Brazil) is that they were not triggered by a large increase in the budget deficit; instead, because the initial equilibrium was so fragile, inflation was in the end destabilized by financial shocks. One important lesson of the new hyperinflations is that the process of restoring price stability has been longer and more costly than in the classical cases. The main reasons for this has been that it was not clear in the minds of the public where inflation would settle once hyperinflation was stopped. In the classic hyperinflations of Europe in the 1920s, expectations were that inflation would return to the low levels that had prevailed before. In the new episodes, there is no compelling reason for agents to expect that the economy would go back to low inflation. Experience showed that inflationary expectations initially settled near the level where inflation was prior to hyperinflation. As a result, the disinflation process must continue once hyperinflation is stopped.