Over the last twenty‐five years an anti‐Keynesian orthodox approach has envisaged a prominent role for reductions in fiscal deficits in developing countries. Expansionary fiscal policies have been said to result in excessive expansion of aggregate demand leading to current account deficits and inflation, as well as displacing private investment, thereby inhibiting output stabilization and employment recovery. Moreover, chronic fiscal deficits are supposed to be associated with high and explosive debt/GDP ratios. The purpose of this article is to assess the theoretical adequacy of the orthodox approach in the context of developing countries. The author clarifies some common misunderstandings and finds that none of the conventional arguments against fiscal activism is wholly convincing. At the heart of the debate lies the question of assumptions, economic structure and causation mechanisms. The orthodox stories regarding the macroeconomic effects of fiscal policy very often do not go beyond the simple monetarist assumptions or seek to verify the implications against the existing experiences and empirical data from developing countries.
In contrast with the inflationary finance story, inflation acceleration in Latin America has been explained as the result of the interaction of inflation dynamics and the frequency of wage adjustments. Accordingly, small inflation disturbances are connected with a shift from moderate to high inflation (or beyond to hyperinflation) though a mechanism that makes adjustment intervals in wage contracts endogenous. Rudiger Dornbusch (1986) labeled this process the "Pazos-Simonsen mechanism". In this note we summarize the basic contribution of both Felipe Pazos (1978) and Mario Henrique Simonsen (1983) and find crucial differences between their views on wage dynamics, specifically regarding the endogeneity of the time interval between wage readjustments. A remarkable affinity with Pazos's view on wage dynamics and inflation is found in an early and almost unknown essay written by Nicholas Kaldor in 1957 (inspired in his brief experience in Latin America).
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