External shocks, financial reforms, and stabilization attempts in Uruguay during 1974–1983

Abstract

This paper interprets and evaluates Uruguay's reforms emphasizing the outcome of financial reforms and attempts to bring down inflation. It is shown that domestic interest rate deregulation and the removal of prohibition towards holding dollar-denominated assets led to a rise in the ratio of financial assets in GDP and to a shift towards dollar-denominated assets. Causes of the persistent and large spread between peso and dollar interest rates adjusted for the preannounced rate of devaluation ( tablita) are examined. The discussion of the stabilization program during 1979–1982 and its aftermath in 1983 shows that setting the tablita at less than the difference between internal and external inflation led to severe imbalances. Because of remaining redundant protection and price stickness, the real exchange rate appreciated sharply for a prolonged period and the trade balance widened until the stabilization episode ended with capital flight when doubts set in about the sustainability of the tablita.