Introduction

At the end of the 1970s, several Latin American countries pursued a new kind of stabilization programs. These programs, which have been labeled “new style,” mixed some variant of exchange rate targeting with monetarist-oriented stabilization policies (see Diaz Alejandro 1981, Dornbusch 1982, Calvo 1983). The interest for these programs, when they were first put in place, came from their stark differences from the traditional International Monetary Fund (IMF)-sponsored plans. The latter relied on nominal exchange rate adjustments to correct relative price distortions and on budget discipline to stem the pressures to inflate. The former, instead, aimed at fighting inflation through nominal exchange rate pegging. In addition, another important pillar of the “new style” programs was an increase in nominal interest rates as part of a package of liberalization of domestic financial markets and international capital flows.

The idea of stabilizing inflation through the exchange rate gained increased popularity in the 1980s, with the prominent examples being the Israeli stabilization and the experience of European countries. After 1983, the high-inflation countries that belonged to the exchange rate mechanism of the European Monetary System (EMS) took a stronger resolve on the stability of their exchange rate vis-à-vis the low-inflation country in the system, West Germany. The relative longevity of the EMS, the enthusiasm for the single-market program in the EC and the liberalization of international capital flows all contributed to making the exchange rate mechanism of the EMS a pole of attraction for many countries, both within and outside the EC.