418 Inflation and Stabilization
have been those in which urban “popular sector” and labor groups have been
mobilized into populist parties within relatively polarized party systems. Such
high-conflict countries also had the greatest difficulties stabilizing in the 1980s,
particularly where stabilization episodes overlapped with transitions to democratic
rule. It is difficult to disentangle lines of causality because the size of external
shocks and initial disequilibria posed greater difficulties for the large Latin American
debtors, but the vulnerability to external shocks was itself partly the result of
previous policy choices.
The structure of interest groups and the nature of the political regime are, of
course, not easily changed. Other political factors affecting fiscal outcomes may
offer greater scope for reform, though. The political difficulties of macroeconomic
adjustment appear to be less severe where decision making is relatively centralized
within the government and insulated from rent-seeking pressures. This suggests
the importance of institutional reform for sustaining credible macroeconomic policy.
THE POLITICAL ECONOMY OF INFLATION AND STABILIZATION
Albert Hirschman has pointed out that “the explanation of inflation in terms of
social conflict between groups, each aspiring to a greater share of the social product,
has become the sociologist’s monotonous equivalent of the economist’s untiring
stress on the undue expansion of the money supply.” To construct a political theory
of inflation and stabilization demands an explication of the precise mechanisms
through which political variables contribute to increases in the price level and
difficulties in stabilization.
In studies of the advanced industrial states, cross-national variations in inflation
have been traced to differences in wage-setting institutions and relations among
business, organized labor, and government. Wage policy has played a role in
efforts to control inflation in the developing world, but a growing body of evidence
suggests that fiscal policy is a more appropriate focus for an examination of the
political economy of inflation in developing countries. Since developing country
governments generally have limited scope for domestic borrowing, financing
fiscal deficits usually involves recourse to foreign borrowing and the inflation
tax. There appear to be few cases of severe and prolonged inflation in the
developing world that were not associated with fiscal deficits financed by money
creation.
Fiscal policy also helps explain the accumulation of debt and the subsequent
vulnerability of debtor countries to external shocks. When net capital inflows
ceased abruptly in the early 1980s, debtors were unable to cut expenditures
and raise revenues quickly. They thus relied on instruments that constituted
implicit taxes on financial intermediation, with adverse consequences for
investment.
Not surprisingly, fiscal policy has been central to stabilization efforts.
International Monetary Fund stabilization programs invariably target some
monetary indicator as the key performance criterion, but the focus on monetary
policy reflects the availability of data and the political problems of appearing to