Crisis, Stabilization, and Economic Reform This Page Intentionally Left Blank Crisis, Stabilization, and Economic Reform

Crisis, Stabilization, and Economic Reform This page intentionally left blank Crisis, Stabilization, and Economic Reform Therapy by Consensus Michael Bruno CLARENDON PRESS · OXFORD 1993 Great Clarendon Street,Oxford OX2 6DP Oxford University Press is a department of the University of Oxford It furthers the University's objective of excellence in research,scholarship, and education by publishing worldwide in Oxford New York Auckland Bangkok Buenos Aires Cape Town Chennai Dar es Salaam Delhi Hong Kong Istanbul Karachi Kolkata Kuala Lumpur Madrid Melbourne Mexico City Mumbai Nairobi São Paulo Shanghai Taipei Tokyo Toronto Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries Published in the United States by Oxford University Press Inc.,New York © Michael Bruno 1993 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system,or transmitted,in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law,or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press,at the address above You must not circulate this book in any other binding or cover and you must impose this same condition on any acquirer British Library Cataloguing in Publication Data Data available Library of Congress Cataloging in Publication Data Bruno,Michael Crisis,stabilization,and economic reform: therapy by consensus / Michael Bruno. “Clarendon lectures.” 1. Inflation (Finance)—Israel. 2. Economic stabilization—Israel. 3. Israel—Economic policy. 4. Israel—Economic conditions. 5. Inflation (Finance). 6. Economic stabilization. 7. Economic policy. 8. Economic history—1971–1990. I. Title. HG1210.B78 1993 338.9–dc20 93–16300 ISBN 0-19-828663-5 Dedicated to the memory of my father and mother, who inspired both reason and soul This page intentionally left blank Preface and Acknowledgements This book studies the anatomy of severe economic crises as well as comprehensive programmes designed to effect their cure. My interest in this area has been both academic and practical,the latter from the point of view of a policy adviser and more recently also as a policy maker. Along with many colleagues,I share a sustained scienti fic interest in studying the puzzles and normative economics of countries,like my own,that once enjoyed an enviable growth record and reasonable price stability,but went into protracted high in flation and low growth crisis in the 1970s and/or in the 1980s. I was also fortunate enough to have the opportunity to put some of my ideas (and those of others) to the test, primarily in my own country and,more marginally and indirectly,through mutual discussions with policy makers,in several other countries. Each of these two types of involvement might have justified a separate research product,not least because of the different degree of detachment and objectivity with which they can be pursued by the same author. Given the timing and my preoccupations,however,such separation was not feasible. This book therefore attempts to combine a detailed first-hand account and analysis of a quasi-laboratory experiment in one country with a somewhat more detached comparative study of this and related crises,stabilization efforts,and reform episodes in Latin America. A brief assignment by the International Monetary Fund in early 1992 also enabled me to incorporate a preliminary comparative evaluation of the new (and quite different) reform environment of Eastern Europe. An earlier version of this study originated with a set of three invited Clarendon Lectures which I gave at Oxford University in 1988. The pressure of my duties as Governor of the Bank of Israel prevented me from writing up my lecture notes in promised book form at that time. This may have proved a blessing in disguise. Post-stabilization developments in the Israeli economy,the viii PREFACE AND ACKNOWLEDGEMENTS successful similar 1988 stabilization programme of Mexico,as well as the reform process in other Latin American economies have,since delivery of the 1988 lectures,unfolded in many interesting,often unexpected,and divergent ways. Moreover,since the dramatic political opening-up of Eastern Europe in 1989 there have been the added preliminary lessons of an attempt to apply shock therapies and far-reaching reforms in a much more complex environment. The result is a considerably looser connection between the original lectures and the present book than would normally be warranted. As experience accumulates one gets a better feel for the practical and theoretical intricacies of the adjustment and structural reform process in a greater variety of middle-income countries. Detailed case-studies are necessary building- blocks,but they remain isolated unless an attempt is made to look for common elements without which no scienti fic edifice can be constructed. On the other hand,premature generalizations in an area such as this can also lead one astray. Somehow one must try to strike a balance,which is what this book attempts to do. There is also a related methodological issue—the inevitable need to take an eclectic approach to the theory of economic reform. Ad hoc implementation of an idea or a programme of action has often preceded systematic ex post theorizing about why it might or might not work in a particular context (the application of wage–price controls is only one example). This may also explain why,at this stage of our knowledge,it is unlikely that one discipline or theoretical approach can give a full answer to the varied questions that arise in such context. The case-histories and respective policy episodes analysed here involve interesting angles that come under the heading of economic history,open- economy macro-economics and growth,public finance and monetary theory,and last,but not least,political economy and political science. Their respective tools are relevant to the analysis and,at the same time,there is something to be learned in these fields of study from the case-histories that are our subject of enquiry. While part of the theoretical literature cited in this book can at times become quite technical,I have tried to keep the discussion as non-technical and intuitive as possible. With the exception of parts of Chapter 3 (on the inflationary process),mathematics and formal econometrics are entirely avoided,in the hope that this PREFACE AND ACKNOWLEDGEMENTS ix will make the book accessible to a wider audience with no more than very basic training in economics. This book would not have come into existence without the generous support of institutions and the collaboration and help of many individuals over the years. The National Bureau of Economic Research in Cambridge,Mass.,headed by Martin Feldstein with Geoffrey Carliner, generously continued my past enrolment as Research Associate even while I was in public office. This,plus the remnants of an NSF grant,enabled me to ‘escape’ for very brief summer stays during 1987–90,thus keeping one foot in research and writing. My stay as Visiting Professor at the Department of Economics at MIT,in the academic year 1991/2,for which I thank Rudi Dornbusch and Peter Temin,as well as the facilities of NBER,provided a very congenial means of taking a year's break,to write up this book and discuss its contents,after completing my five-year tenure at the Bank of Israel and before returning to my teaching duties at Hebrew University. No less heartfelt thanks go to WIDER in Helsinki,to its Director Lal Jayawardena ,as well as to the McDonnell Foundation for providing the financial support during part of 1991/2. Likewise,I am very grateful to the Research Department of the International Monetary Fund for enabling me to stay as Visiting Scholar during part of that year. Finally,I thank Balliol College in Oxford for generously hosting me during the 1988 lecture series. Attempts to solve economic puzzles and the design of economic policies were the result of numerous discussions, debates,joint papers with and among many individuals,not all of whom can be mentioned in the preface to a book. Among those to whom I owe most I would like to single out Stanley Fischer,who has been much more than my co- author in two papers that were central to my thinking on high inflation and its stabilization. Stan has played an important role both in the analysis of the inflationary process and its cure and,together with Herbert Stein (as US advisers),in facilitating the actual implementation of Israel's stabilization programme at a crucial stage. He has since then been a constant source of personal support and advice and, finally,has carefully read a draft of this book and given many very valuable comments. x PREFACE AND ACKNOWLEDGEMENTS I have shared with several Israeli colleagues the excitement of being involved in the fascinating Israeli stabilization experience. To Emanuel Sharon,Director of the Ministry of Finance at a crucial planning and policy implementation period,I owe my own involvement in the planning team in 1984 –5 as well as a very fruitful policy collaboration after my appointment to the Bank Governorship. Numerous discussions with,and the sharp insights of,Nissan Liviatan, my colleague at the Hebrew University,both in the planning stages and during the interesting post-stabilization developments,have been a permanent source of help and pleasure. It is with deep sorrow that I have to mention Eytan Berglas,of Tel Aviv University,as one who is no longer with us. His sudden and untimely death in August 1992 has deprived the Israeli economics profession of one of its most erudite and exemplary members.

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