INTRODUCTION

The Southern-Cone stabilisation programmes of the late 1970s brought new challenges to economic theory. The underlying idea behind these programmes was that by pegging the exchange rate to the dollar, the inflation rate would rapidly come down to international levels. However - and to the surprise of policymakers - the inflation rate failed to converge quickly to the preannounced rate of devaluation, which resulted in substantial real appreciation of the domestic currency. Real economic activity expanded in spite of the real appreciation. Later in the programmes - and even before the preannounced exchange rate system was abandoned - a recession set in. The eventual slump in economic activity that took place in the Southern-Cone programmes gave rise to the notion of 'recession now versus recession later', in comparing stabilisations based on controlling the money supply with stabilisations based on fixing the (rate of change of the) exchange rate (hereafter referred to as money-based and exchange-rate-based stabilisations, respectively). The idea was that, under money-based stabilisation, the costs (in terms of output losses) would be paid up-front, whereas, under exchange-rate-based stabilisation, the costs would be postponed until a later date. Thus, choosing between the two nominal anchors was viewed as choosing not if but when the costs of bringing down inflation should be borne.

Almost half a decade later, the ‘heterodox’ programmes of Argentina, Israel, and Brazil brought to life once again some of the same - and still mostly unresolved - issues. Real appreciation was very much part of the picture in spite of the use of wage and price controls. More puzzling, however, was the re-emergence of the pattern of an initial boom and a later recession. The Israeli recession was viewed as particularly hard to rationalize because of its occurrence in a fiscally sound and largely successful programme. It then became clear that economic theory had to come to grips with the issue of an eventual recession in an exchange-rate-based stabilization programme.