Political Stabilization Cycles in High Inflation Economies

Abstract

High inflation economies often do not exhibit smooth inflationary processes, but rather stop-go cycles. This paper relates these stop-go episodes of inflation to a political cycle. The government can try to repress inflation until after the elections in order to increase the chances of being reelected. It is modeled as a two-period game of incomplete information where voters try to pick the most competent government, and inflation can be lowered by the government in the short run through foreign debt accumulation. Several stabilization episodes in Latin America, such as the Primavera Plan in Argentina and the Cruzado and Real Plans in Brazil, are used to illustrate the model.