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Econometrics and the Design of Economic Reform

Michael Bruno

Abstract

The concept of economic reform is described as a planned shift from one, Pareto inefficient, but quasi-stable, equilibrium (or "trap") to a new Pareto superior equilibrium which is, or is designed to become, stable too. The concept is applied to recent "shock" stabilization programs, with special reference to Israel, where the economy was credibly shifted from a 3-digit inflationary process with considerable inertia, to relative price stability with higher real growth, at only small adjustment costs, by means of a "heterodox" plan. This two-pronged stabilization program consisted of a substantial correction of budget and external account "fundamentals" together with a synchronized, wage-price-exchange rate freeze. The idea is theoretically rationalized within a simple dual equilibrium inflation model, for which some econometric estimates are also given.