Monetary and Fiscal History of Peru 1960-2010: Radical Policy Experiments, Inflation and Stabilization

César Martinelli (of GMU)  and Marco Vega (Central Bank of Peru) in this paper review the economic history of Peru:

Peruvian recent economic history is marked by an ambitious attempt to refashion the economy of the country through command-and-control policies adopted by a left-wing military dictatorship from 1968 to 1975. After the military returned to the barracks, they left as a legacy an expansive state, precariously financed through debt accumulation and inflation tax. The hyperinflation of the second half of the 1980s occurred in the midst of another radical policy experiment. The policies adopted by the populist administration then in office, such as pervasive price and exchange controls, were counter productive by and large. These policies also made it hard or impossible for the following administration to rely on a exchange rate peg to anchor expectations as part of the stabilization policies.

Looking back, it is hard to miss the fundamental mistrust in market allocations by economic and political actors in the run-up to hyperinflation.26 Mistrust was compounded by wishful thinking by government authorities, in particular during the episodes of 1968-1975 and 1985- 1990. Remarkably, a radical policy gamble attempted in the latter experiment was stopped by popular protest. In a way, society learnt faster than the political elites, and popular repulse of
arbitrary government intervention in the economy preceded the stabilization of 1990.

The stabilization of 1990 was preceded by other attempts that looked ex ante similar. The question arises as to why this particular attempt was successful, leading to a persistent change in policy regime. Moreover, why did the same, or very similar, politicians behave more responsibly in fiscal and monetary matters after stabilization? The recent history suggests a process of social learning.

From this viewpoint, the credibility of policy regime change in the 1990s may be linked ultimately to the change in public opinion giving proper incentives to politicians. Both the dollarization of the economy and the respect for central bank independence which are currently characteristic features of Peru’s economics and politics, can be traced back to some extent to the effect of the traumatic events of the 1980s. Borrowing the phrase of Malmendier and Nagel (2011), those who lived through those events are “hyperinflation babies.”

History matters. Wherever you are…

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