On the contractionary effects of expansionary fiscal policy, sustainability, and income distribution in Argentina (cont.)

This post appeared in RGE-Monitor (Latin America) on December 9, 2008.

Fiscal Accounts Shortage (flows). In response to the crises, the government has announced a battery of government expenditures’ increases and (subsidized?) credit supply with the pension funds recently nationalized—very likely reducing the rate of return to future retirees instead of increasing them, the main official argument for nationalizing these funds in the first place. I argued in a previous post about the contractionary effects of these measures. This seems to be exacerbated by the fact that tax revenues are markedly slowing down—as predicted (not by the government, though). Unfortunately, this seems to be just the starting point, as tax revenues are likely to contract in real terms in the short-run, while spending seems to be on the rise.

Financial Account Shortage. The central bank is trying to help by gradually letting the domestic currency depreciate. This should come at no surprise. Capital flows have been leaving Argentina, exports are now decreasing in quantities (prices have already started their downward movement before), and neighbor countries let their currencies depreciate in response to the external change in relative prices. That helps to explain the need for the government to let capital that out-flowed to return in too benign conditions—although, rationally, I would expect this not to work, as a strong driving force for capital flows is confidence in the country and respect for property rights; neither high in Argentina nowadays. Add to that that, in parallel, the administration is trying to enforce restrictions for capital outflows. But if the domestic currency is expected to continue depreciating and capital finds it difficult to exit the country, why will it enter in the first place? Additionally, in collaboration with Carmen Reinhart (University of Maryland and NBER) and Ken Rogoff (Harvard University and NBER) I have shown that capital controls do not work!

I can only hope for the government to be smarter (am I being too optimistic?) and just making announcements knowing that they will not be enacted—trying to look “as if” they are doing something (and in control) regardless of the truth. Because if not, Argentina is poised to fail sooner rather than later. Alternatively, I guess political economist will have (even more) material to work on.

Fiscal Accounts Shortage (stocks). Let me now factor in the fact that debt to GDP ratio is in levels similar to the 2001-2002 crises.

This is so even if not including the quasi-defaulted CPI-indexed debt (roughly 40% of total recognized public debt) and borrowing from the central bank. Regarding the latter, it includes not only the so-called “transitory advances”, but also the new debt contracted by the treasury in order to pay to the IMF (wrongly dubbed as “de-indebtedness”). The latter is not part of the country’s public external debt, but it is debt denominated in foreign currency—thus, it increases in real terms as the domestic currency depreciates. Granted, the percentage of (the recognized) public debt denominated in foreign currency decreased from close to 97% to 53%, which is likely to be reduced in real terms as the peso continues to depreciate. However, it basically means that Argentina is in route to renege on part of its financial obligations either through inflation, depreciations, or both (conditional on the degree of pass-through).

This is compounded by the fact that the fiscal surplus is mainly used to make interest payments, rolling over most of the debt. Worse, the government’s lack of financing availability implies canceling outstanding debt by borrowing from different government agencies (intra-government debt). Within those, of course, is the nationalized pension fund. Not surprisingly, the latter tends to lend to the government at negative real interest rates. (I hope you are not among those to retire in the near future.) Thus, nothing precludes the level prior to the debt swap (2004) to be reached quite soon—especially if you add the debt issued to the central bank, the hold-outs, and the present discounted value of the lawsuits that the government will face as a result of the AFJPs nationalization, among others. The more so if we consider that the fiscal budget law enables the government to increase its ability to borrow from the central bank and from Banco Nacion (the main public bank).

Bottom line: Argentina apparently intends to increase its outlays while the expected revenue seems to be trending down. The indebtedness ratio has already reached levels similar to those of the latest default and the risks are in the upside. On top of these, the world that helped (a lot!) in the 2002-2007 period is looking quite gloomy. The U.S. seems prone to be in recession throughout 2009, and the recovery looks sluggish—below potential GDP during the H2 of 2010. Europe and Japan do not look much better. Asia depends mainly on exporting to developed countries. In particular, China growing at 7.5% is not promising enough, as Nouriel Roubini pointed out in his blog. This certainly affects Brazil and Russia as a consequence. Overall, it ends up impacting Argentina quite seriously. But had Argentina “made its homework” during goods time, things would have looked extremely differently now. Now the due date for the assignment has passed.

P.S.: It is also worth mentioning the regressive income redistribution embedded in these policies. Out of tax revenues and retirement funds (which all workers, rich and poor as far as they are registered workers, pay at the same rate), the government plans to subsidize credits for new cars and other durable goods. But who is more likely to receive these credit lines—provided that they are credit worthy and willing to borrow? (The willingness might result from expected negative real interest rates, though; provided you are quite optimistic about your expected future income.) On average, not lower income people. Actually, if any, those that are paid in dollars could be the more likely ones to take advantage of this consumption subsidized credits—usually not poor people.

Thus, not only these counter-cyclical fiscal policies might be contractionary, and potentially de-stabilizing for financial markets and triggering high risk of default. On top of all these things they worsen income distribution markedly. This sounds contradicting for a so-called “progressive” government—but not for a populist one.

Argentina and the contractionary effects of expansionary fiscal policy

The following posting appeared in RGE-Monitor (Latin America) on Nov. 18, 2008.

In an article published in The Journal of Macroeconomics[1] I show how information frictions could lead to asymmetric business cycles both in terms of magnitude and of the length of the return to trend. Negative shocks are amplified more than positive ones; also, negative shocks depict rapid contraction while the recovery is more protracted.

Two to Tango: your savings but my expenditures; and the re-coupling of the financial channel—or: the Tango Effect Returns?

The following post appeared in RGE- Monitor (Latin America) on October 23rd, 2008.

Argentina’s (government) is decoupled (of common sense): when there was a global expansion in commodities (the so-called tailwind) the administration pump up aggregate demand (with inflationary effects and resource misallocations). Now, as the global economy slowdowns sharply, affecting U.S., Asia, Europe and Brazil (Argentina’s main trading partner); not only commodities’ prices, but also external demand decreases. Thus, the trade channel was expected to be the main source of the negative shock—after all, Argentina had almost no access to international financial markets (not only due the 2001 default but also due to policy applied since then). But Fernandez de Kirchner is causing the financial channel to re-couple. While the world economy is progressively trying to stabilize in baby steps, Argentina’s government plants the seeds of its own destabilization. The Tango effect might be approaching: debt default? (the country risk is close to 2000 pts.), the government almost repudiating its obligations, unemployment and volatility with upside risks, output with downside risks (all of which point to even lower than expected revenues in the near future and the medium run), increase in demand for dollar deposits—the Central Bank probably losing international reserves in the process. Will the exchange rate be devalued? My sense is not whether the domestic currency will depreciate or not, but at what pace. It seems that the central bank intends the depreciation to be progressive, gradual. But, will that be possible?

Is always easier to blame “the marketplace and the neoliberal policies;” or is that the current administration is in a way forcing market forces to act—it is always simpler to blame it for your mistakes…

It is worth mentioning that government debt is still highly dollarized, while revenues—in domestic currency—will tend to decrease, and funding is already extremely limited and poised to freeze, the more so with the socialization of pensions with a decreasing revenue to finance the PAYG social security system.

How will this end? I leave to the smart reader to answer this quite obvious question.

Is Argentina running out of funds?

The following post appeared in RGE- Monitor (Latin America) on October 20th, 2008.

The Argentine government is, apparently, in the process of reabsorbing the retirement and pension system privatized in the 1990s’. The official argument, of course, is the international financial crisis. (Wasn’t Argentina de-coupled, and totally resilient to the crisis, as per the authorities?). I would interpret it differently, though. The government seems unable to rein in public expenditures. In turn, this is worsened by 2009 being an election year in the context of an economy that slowdowns markedly (and mainly due to internal wrong macro-management much more than and prior to the external shock), and very limited financial access—I have elaborated extensively on these topics in previous posts and the use of temporary high tax revenues to finance quasi-permanent expenditures. You can also add a presidential image that plummeted through 2008. Thus, the government is desperate to obtain funds to increase expenditures, which are quite scarce for Argentina.

Some commentators argue that the external shock calls for a fiscal response to smooth the business cycle—that should not exist in the first place as per the previous calculations of the government regarding the international shock. Isn’t the U.S. doing it? But Argentina is not the U.S. Clearly, its default history differs substantially, as well as respect for property rights; and the list follows on and on. Only when a country’s reputation is high enough is that economy able to step in to temporarily buy equity in firms to stabilize a crisis. This does not apply to Argentina’s current administration.

But this is not new. The Kirchners ‘administration have made use of this “tricks” more than once—and so did Peron. In the name of retired people’s benefits—not true, though—the administration is able to obtain current funds that otherwise will be unable to borrow. The intertemporal magnitude of this is not trivial: by acquiring the present flow of funds to finance current (but potentially quasi-permanent) expenditures, the federal government also incurs in present and, more importantly, future liabilities (mainly not taken into account)—not to mention the efficiency losses derived from “governmental” managers not usually chosen due to their technical ability. Will this affect the future ability to roll-over debt? This is still an open question. No wonder that Argentina’s country-risk increased—and might keep on increasing. Furthermore, the short run impact of this affect the banking system—probably the only sector with some resilience of the crisis, since the real sector will be strongly affected.

Add to the latter that the government wants to exchange its debt—so as to transfer over time the burden of capital repayment—would you like to be in charge in 2011? I wonder if someone will…

Finally, let me comment on the response of the current administration to the international financial crisis. The idea seems to be to increase public expenditures (as mentioned above), closing the economy and potentially gradually depreciating the exchange rate. Closing the economy is not the right answer. The adjustment of the exchange rate would have been correct, provided that the past macroeconomic policy had been responsible—the latter not being true. Had Argentina respected property rights, not manipulated inflation and other official data, pumping up the economy to increase inflation, stimulated investment (instead of only consumption) and productivity, etc, the answer would have been different. But now, however, there is higher probability that changes in the exchange rate will be transferred to prices—nobody will be surprised why this did not happen in Brazil or Chile, right? The administration preferred not to slow down the economy to control the inflation rate when things were manageable. May be it is time to start paying the bills (sooner rather later).

Pro-cyclical government expenditures and commodities’ prices in Latin America (and Argentina in particular)

The following post appeared in RGE-Monitor (Latin America) on September 8th, 2008.

The pro-cyclicality of Latin American fiscal policy has been extensively documented (see e.g., Kaminsky, Reinart, and Vegh (2004), Talvi and Vegh (2005), Hausmann and Gavin (1997) among many others). The recent boom in commodities’ prices that started in the early 2000’s add one additional set of observations to extend this literature, albeit with some important differences.

Some countries internalized the temporariness of the boom in commodities’ prices and fiscal expenditures were increased accordingly. One example of the latter could be Chile, where what can be computed as the permanent component of the terms of trade shock can be spent while the transitory component has to be saved for the long-term purposes.[1] In a way, another case can be made of Brazil were the government stimulates investment in the agricultural sector to take advantage of this boom such that that the country can obtain long run benefits of this temporary boom. The list does not end here.

However, other countries did exactly the opposite: spend permanently based on this transitory shock. Argentina, unfortunately, fits this case. Government expenditures have been increasing at very high rates—higher than GDP. Granted, tax revenues also increased substantially—the economy emerging out of one of the worse crises in its history jointly with the international boom in commodities’ prices and an increasing inflation, though (i.e., based on temporary sources).

Commodities’ prices have been (as expected) progressively reverting down—a correction to their long-run level—and this could be expected to continue. At the same time, international financial turbulence started over a year back and it is still not done. During this time period, as mentioned above, Argentina has been engaged in a spending spree that has accelerated, among other things, due to subsidizing consumption as the “anti-inflationary” strategy—along with price controls. It is not the purpose of this piece to elaborate on the causes of this explosion in government expenditures; although the main reasons seem to be political objectives matched with some misunderstanding of (short-term vs. long-term) macroeconomic management.

It’s worth mentioning that (only) some current measures seem to go into the correct. However, will that be enough? That still needs to be seen. So far, the measures look more like stray signals rather than a true and deep change in the macroeconomic policy. This is not without a cost, though. Even if the government engages in the required long term corrections, given the delay already observed, regressive income distributions could happen. History has a lot of observations that show how populist government expenditures pro-cyclicality end.

Given the observed response of government expenditures to these external shocks, some yellow lights are:

1. Fiscal fragility (and capital account?) likely to worsen. Expenditures: Will government expenditures be reign in? Actually, it looks like the opposite—as per the 2009 fiscal budget act project. The government is looking for alternative instruments to finance higher expenditures—like enabling the currently forbidden lending from the Banco Nacion (the major national public bank, where the government deposits its money), but not reducing them. The latter resembles, in some aspects, the old-fashioned (central bank’s) quasi-fiscal deficit which tends to worsen inflationary situations. Some cosmetic accounting has been used to try to show a fiscal surplus that is not really as strong as claimed (central bank transfers plus arrears)—so now even the flow balance is becoming fragile—not to mention the intertemporal stock. On the revenue front, if commodities’ prices keep on correcting and the real exchange rate appreciating (domestic inflation plus an appreciating dollar as commodities revert to long-run trend) they would tend to decrease. And what if the current account moves to a deficit (chances now increasing)? What will happen with the quasi-fixed exchange rate? Will the so-called “exchange scarcity problem” reappear?

2. Financing problems. High interest rate: lack of international lending to Argentina; that’s why the administration decided to repay to the Paris Club (in cash though, instead of through the IMF, as would have been wiser). Showing this willingness to pay is good news but not enough and probably with less impact on the country’s credit constraints than truly putting the macroeconomic policy in a sustainable path. Let’s notice that even though the repayment might (marginally) reduce the interest rate, this effect favors investment projects. Without correcting the whole macroeconomic policy-frame investments are unlikely to be many anyway. That means spending almost 15% of international reserves (close to $7,000 out of $47,000) for probably not much future return—losing reserves when the world economy will probably provide less foreign exchange to Argentina as commodities’ price decrease and the world economy slows down—increasing the chances of systemic risk. Worse, the only “benefits” would be more expansionary aggregate demand (not surprising given elections next year). The latter, jointly with any interest rate reduction will clearly not contribute to control the high domestic inflation.

3. Inflation. Domestic inflation has substantially separated from world inflation. However, so far the government seems to lack an inflation stabilization plan—other than stabilizing at the already high levels, which depresses long-term growth.

4. World economy slowdown. The U.S. seems to be headed to slower growth—in the brink of recession. Europe and Japan do not look much better. This is likely to affect Asia since the latter’s exports are mainly driven to developed countries. As a collateral effect I can not discard some effects on Brazil, a huge trade partner to Argentina which, by the way, has done the right job by tending to cool its economy to keep inflation under control. This is not without recessionary impact, as should be; thus, all else equal this would contribute to worsen Argentina’s external balance.

Notice that all of the above, among other things, involve a strong control of government expenditures as (part of) a corrective device. Reduced public spending not only increases the present fiscal balance, but also improves its future stance. It ameliorates the government financing pressures, contributes to control the inflation rate by reducing aggregate demand at the same time that frees up financing resources (and reduces interest rates) for the private sector—the old-fashioned “crowding-out” effect—and tends to depreciate the real exchange rate, thus helping the exporting sector.

All in all, it seems that Argentina needs a comprehensive macroeconomic reform to wisely take advantage of the commodities boom windfall, and stop always being behind the curve. The problem is that this external shock is currently slowing-down for good. So far, the country has only benefited from the boom’s short run externalities, discounting the long-term effects as second order. The above points just signal the lack of this type of strategy, and implies that not only has Argentina not paid much attention to the (infrequent) opportunity that the world economy has provided to catch up with the developed world—it has almost nullified its long-run positive effect. This seems to be a positive externality. However, Argentina is responding with a negative strategic complementarity…

Notice that since debt obligations involve a temporal links, fiscal policy is extremely important. Not only past and present fiscal policy matters (reflected in (1) above), but also the future effects of current fiscal policy ((1), (2), and (3)), as well as the current expectations on future fiscal policy ((1), (2), (3), and (4)). Let’s add that 2009 is an election year and the administration since 2003 has pursued aggressive fiscal expansions during election times. The more so for a politically weak government (i.e. a government with a low political capital) that does not internalize the amplification and propagation of its own policies and the world economy’s shocks into the future of the country’s volatility and growth.

On a positive note we can argue that for this to end on an economic crisis we need to observe some events with joint probabilities that are difficult to happen. On a negative note, however, although difficult, these joint probabilities seem not impossible—and the government contributes to make them more likely.

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[1] See Izquierdo, Talvi .and Ottonello (2008) for details.

Is (the Kirchners’ self-inflicted) Potential Hyperinflation Possible (Again) in Argentina?

The following appeared in RGE Monitor (Latin America) on August 1, 2008.

This is a valid question to ask ourselves, as the Kirchners’ administration has consistently pursued populist economic policies that usually end in a hyperinflation episode. This becomes more relevant if we review the economic history of the country. Once and again we have seen a sequence of events, many of which we have been observing during the past years, that ended badly. A short list follows.

- Wage increases not only increase in frequency, but also in magnitude: during the last agreement (late July) minimum wage increase was in order of 27%—after having been raised closed to 20% in H1.

- Tax revenue is mainly driven by the inflation tax (e.g. VAT) and the external boom (export taxes); the latter not being permanent.

- Government expenditures increase at very high rates (in the 40% area). The government so far has been unable or unwilling to rein it in.

- Given the already high inflation that has been partially and regressively repressed by subsidies, the government is now starting to let some of the “freezed” prices to partially accommodate. This is welcome; but too late. Notice that so far it only intends not to increase subsidies, but not reduce them.

- The so-called fiscal surplus is under big dispute. Its present stance is probably worse than officially argued (as many private sector reports show). The future balance looks much worse.

- Consumption-driven economy—as opposed to investment-driven. This is not trivial. Increases in present aggregate demand derived from investment create the ability to increase future aggregate supply in line with higher aggregate demand. Consumption-driven impulses do not necessarily create an investment stimulus; especially under weak property right—where every profit looks like “extraordinary profits” and thus “taxable to redistribute income”. Of course this ignores the regressive income distribution—present and future—that high inflation causes.

- Tardy (i.e. now that the current stance and especially the future outlook start to look gloomy) increases in retirement benefits. The main motive for this being increase aggregate demand while gaining some political support after the failure in the (export-tax) confrontation with the agricultural sector—as retired people tend to have a relatively high marginal propensity to spend. It is worth mentioning that the conflict with the agricultural sector is far from over, as the government still has plans to re-instate this export taxes, albeit in a different way—the administration needs the cash.

- Price controls to (supposedly and ineffectively) control the inflation rate. This distorts relative prices and potentially triggers repressed inflation. If the latter holds, the relative price correction is rarely swift… And I can’t call this an anti-inflationary plan.

- Annual inflation expectations close to 35%. This seems to be in line with the private sector inflation estimates for the moths to come. The more so if with the price realignment mentioned above is considered.

- Families are highly indebted and the delinquency rate is increasing.

- The real exchange rate has been continuously appreciating as the inflation rate is on the rise while the central bank, in a way, targets the nominal exchange rate.

- Political unrest: not only the President-Vice President recent controversy, but the social unrest in the interior (e.g. Cordoba, Santa Fe, etc.), and, consequently, a politically weakened government—its own alliances melting down due to the policies applied by the presidential couple during the last years.

- History tell us that too frequently in the past Argentina raised wages, utilities, etc., and let some of the relative prices to re-accommodate as a pre-stage to a devaluation (with lots creativity such as splitting the foreign exchange market, fixing the exchange rate, interest rate caps, etc., and an infinite list).

- Luckily the economy has not demonetized (yet?) and the central bank has not depreciated the domestic currency (yet?); as this will probably make the system to explode. But, as a signal, the “founding fathers (both ideologists and implementers)” of this so-called “productive model” are already fleeing away, trying to decouple themselves from it

So, hyperinflation is not a problem in Argentina for the moment. However, I could change this to may be not yet, since unfortunately we cannot disregard it in the future. Unless I assume that the government is intentionally stimulating inflation to reduce (i.e. inflate away) its real expenditures instead of reducing its expenses. If so, somebody would need to remind the authorities of the Olivera-Tanzi effect—and that this basically does not work. This would be totally erroneous since—although worsening as a consequence of its own external tax policy—the surplus in the trade balance is still positive. Things can get really nasty is this surplus disappears…

There is still (little) time to correct this. But among the features that should be included is a strong fiscal correction, freer markets (including relative prices!), better property rights, an independent central bank, a long-term growth strategy (that includes investment incentives along with lower inflation—the latter resulting from a serious anti-inflationary program). However, and against my wishful thinking, next year is an election year. The government has already lost a lot political support, so it could easily be tempted into reinforce the (already failed) populist policies. The more so since the policies that would help recover long-term and stable growth usually take time so enact—probably not enough time until the next election.

Macroeconomic Dynamics and (Present and Future) Income Distribution in Argentina: a Lucas’ Critique View

This post appeared on RGE-Monitor (Latin America) on July 21, 2008.

The export tax law that Argentina’s president submitted to Congress ended as a complete failure for the current administration—the more so since it was finally rejected by the negative vote of the vice-president. However, I look at the episode as the best outcome possible for the current administration. It actually gave the government the ability to start afresh. The vice-president rejection actually enabled the president to obtain an elegant way out of an economic mistake—with potential social unrest. Will the president take advantage of this? Although I truly hope that “words” will actually be contradicted by “facts”, as of today I am inclined to think the answer is not—details follow.

As per the information available it seems that in order to re-boost the high inflation-low growth direction that the economy is taking the government is planning to increase the after-tax wage of middle-income families—and, at the same time, to try to partially re-gain some political support (currently close to 20%). Supposedly, the government intends to provide a fiscal stimulus: increasing the gross income level at which employees start paying income taxes, increasing net wages. That would not surprise any economist if the economy is slowing down to below full-employment. But this is not the case of Argentina. This looks even worse once we factor in an inflation rate in the 30-35% range.

On the contrary, such a policy will more likely end up being the worst of all medicines—potentially killing the patient. For, this will accelerate the (already high) inflation rate, as middle-income people consume more—but firms are unlikely to increase employment. The more so since this policy will probably trigger distributional tensions, as unions will press for further, more frequent, and greater wage increases.

Why do I think that this fiscal stimulus will exacerbate the inflationary pressures? Among many other reasons, I can mention: inflation expectations could jump, aggregate demand could increase due to consumption increasing (but not because of investments as high inflation and interest rates, plus uncertain exchange rate market and property rights call for firms’ caution), and the worsening of the present and future fiscal position. Add to this a global slowdown, more stringent international credit markets (the more so for Argentina), and the fact that the current administration is financing present expenditures that become permanent with transitorily high revenues.

On the latter, we can not only consider the lower real revenue (inflation can compensate partly, but not when demand is going down at an increasing rate), but more importantly this will accelerate the already huge bill that subsidies to the middle- and higher-income represent. And most of these subsidies (energy, gas, public transportation, etc.) benefit relatively more to relatively higher income people—thus it represents a transfer from poor to rich people. It has been suggested that some of these subsidies will be reduced by letting prices increase. This would be great news—if enacted. For, some couple of months ago some of the previously “frozen” prices were permitted to increase a little bit. However, and contrary to what was stated by the authorities at the time, subsidies were not reduced at the time—they actually kept on increasing.

So all in all, this represents a current transfer of resources from poor to reach people. But, it represents a much higher future transfer in the same direction. Eventually the economy will need to be aligned back to trend. This will require a drastic adjustment in government expenditures, interest rate hikes, (real wages contractions?) and, in general, a strong contraction of the economy to correct all the accumulated and increasing resource misallocation and misaligned relative prices (and the exchange rate…?). And the adjustment will need to be greater the longer it takes to be internalized.

Therefore, what I observe is a variety of the classical Lucas Critique problem. The government is planning (again) to pump up (private consumption) domestic aggregate demand not realizing the future effects of these policies. By not internalizing the present and future impact of its own present public policy—thus lacking any medium and long term strategy—it might lose another chance; in this case shifting from economic instability to political instability. Unless they want the political instability to emerge—so as not be made responsible for its own mistakes.

And the worst of all these consequences it the present and future income redistribution (from poor to rich) that this supposedly “popular” (I would say “populist”) administration is generating will do nothing but worsening even more the standards of living of those in the lower income brackets.

Hopefully the available information is wrong and the president figured out that the rejection in the senate has turned into her best chance to achieve the best for the country. We’ll see.

On Populism in Argentina (and other Latin American Countries)

This post appeared in RGE-Monitor (Latin America) on June 25, 2008.

I came across this piece on populism so I decided to share parts of it with you.

“… [E]conomic populism is an approach to economics that emphasizes growth and income redistribution and deemphasizes the risk of inflation and deficit finance, external constraints, and the reaction of economic agents to aggressive non market policies… populist economics ultimately fail; and when they fail it is at a frightening costs to the very groups that were supposed to be favored.

Features:

1. Initial conditions. The populist policymaker—and the population at large—are deeply dissatisfied with the economy’s performance; there is a strong feeling that things can be better. Typically, the country has experienced very moderate growth, stagnation, or outright depression as a result of previous stabilization attempts. This previous stabilization experience often, though not necessarily always, has been implemented under an IMF program and has resulted in reduced growth and lower living standards… The preceding stabilization would generally have improved the budget and external balance (through the accumulation of international reserves) sufficiently to provide the room for, though perhaps not the wisdom of, a highly expansionary program.

2. No constraints. Policy makers explicitly reject the conservative paradigm and ignore the existence of any type of constraints on macroeconomic policy. Idle capacity is seen as providing the leeway for expansion… The risks of deficit finance emphasized in traditional thinking are portrayed as exaggerated or all altogether unfounded. According to populist policymakers, expansion is not inflationary (if there is no devaluation) because spare capacity and decreasing long-run costs contain cost pressures and there is always room to squeeze profit margins by price controls.

3. Policy prescriptions. In light of the initial conditions described above, the populist programs emphasize three elements: reactivation, redistribution of income, and restructuring the economy. The common thread here is “reactivation with redistribution.” The policy recommendation is to actively use macroeconomic policy to redistribute income, typically by large real-wage increases that are not to be passed on into higher prices.

The Phases of Populist Economics

I. The policymakers are fully vindicated in their diagnosis and prescription: growth of output, real wages, and employment are high, and the macroeconomic policies are nothing short of successful.

II. The economy runs into bottlenecks, partly as a result of a strong expansion in demand for domestic goods… Whereas inventory decumulation was an essential feature of the first phase, the low levels of inventories and inventory building are now a source of problems. Price realignments and devaluation, exchange controls, or protection becomes necessary. Inflation increases significantly, but wages keep up. The budget deficit worsens tremendously as a result of pervasive subsidies on wage goods…

III. Pervasive shortages, extreme acceleration of inflation,… lead to capital flight and demonetization of the economy. The budget deteriorates violently because of steep decline in tax collection and increasing subsidy costs. The government attempts to stabilize by cutting subsidies and by a real depreciation. Real wages fall massively, and policies become unstable. It becomes clear that the government is in a desperate situation.

IV. Orthodox stabilization takes over under a new government. More often than not, an IMF program will be enacted; and when everything is said and done, the real wage will have declined massively, to a level significantly lower than when the whole episode began. Moreover, that decline will be very persistent, because the politics and economics of the experience will have depressed investment and capital flight.”

I can personally not agree more with the piece. It is astonishingly actual.[1] If somebody were to write this now, the description of the present situation in Argentina (and some other Latin American countries) can hardly be more accurate. The sad part of it is that this has been taken from a book printed in 1991[2] and based on the Latin American experiences of the 1950s-1980s! So we should have learned from our past mistakes instead of falling once and again on the same errors.

In the current Argentine case it seems that the country is between Phase III and Phase IV, so we should really be worrying. It seems pretty clear that the Kirchners’ administration were able to read the “Features,”… but not the “Phases.”

This has been just a historical piece. But, the question is: Will history repeat itself?

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[1] For further details, some of my past posts elaborate on the present policy problems, including the unsustainability of the fiscal balance, the acceleration of the inflation rate, the pervasive income redistribution, among other things.

[2] “The Macroeconomics of Populism in Latin America,” by R. Dornbusch and S. Edwards, NBER, The University of Chicago Press, 1991.

Sub-prime Crisis: Argentina’s Consumption-Credit Variety

This post appeared on RGE-Monitor (Latin America) on May 28th, 2008.

Global growth during the last five years provided a huge tailwind for agricultural producing countries boosting Argentina’s emergence of one of its biggest crises ever. The government response to this (temporary) windfall in its terms of trade and globalization not seen since the late 1800’s has been to stimulate consumption, instead of investment to capitalize the positive shock for its long-term growth. This can be observed, among many other things, by the huge consumption-credit boom of 2003-2008 (housing credit is relatively small in Argentina), especially to middle- and lower-income families. The domestically generated inflation has exacerbated the extensive use of this form of credit in a potentially unsustainable way.

Inflation, if temporary, can be expected to increase the use of this type of credit. Precisely this is the rational use of credit markets: to finance temporary shocks in order to smooth consumption. However, this is not the appropriate channel for permanent shocks as the current inflation rate, which is not expected to go away any time soon. When inflation starts to accelerate and being incorporated to inflation expectations and the government lacks a serious anti-inflationary program, and real wages start to decline, consumption is likely to lose pace. In this context, it should be expected that lower-income families in countries in which the share of food and basic stuff is non-trivial to being unable to meet all the required payments—the more so the higher the inflation rate—and for such repayments to be put on hold.

Paralleling the home-oriented sub-prime crisis in the U.S. where many credits where extended without the appropriate credit revision, many consumption-loans have been extended in Argentina. Although the amounts involved are lower, the collateral is worse: there is no home to be absorbed by the financial institution in case of default. And many credits were issued not only to buy cars or refrigerators, but also to buy clothes. Recent data from the central bank shows a substantial increase in delinquency rates in these types of credit, which doubled. Recent studies expect the delinquency rate to increase due to higher inflation.

A big share of these lending has been directly extended by stores selling these goods and financial institutions. These credits are then pooled and these financial instruments are then sold in financial markets—the so called financial fiduciary funds—which are supposed to hedge upon risk. As of now, middle and low income families are, on average, indebted on 80% of the monthly household income—for higher incomes this reaches five times the monthly income!).

Although the scale is much smaller, any resemblance to the U.S.? The rest is let for the smart reader to figure out.

Argentina: Some facts and some thoughts

The following post appeared in RGE-Monitor (Latin America) on May 9th, 2008.

Some (common knowledge) facts
- The inflation rate keeps on accelerating—there are suggestions that unions are seeking to renegotiate in H2 the ex-ante annual wage increases arranged around March (of this year!).

- Government bonds are being consistently rejected, their price decreasing; they would have fallen more if it weren’t for public institutions (e.g. public banks) aggressively purchasing them.

- Country-risk has increased.

- S&P put Argentina’s debt in “negative”.

- Government mismanagement, as expected, pushed the farm sector back into strike mode. This time, and to try to avoid food scarcity in cities, the farm sector will stop export products.

- The effect of the latter: reduced tax (export) revenues; if it also implies a reduction if expenditures (likely), it will imply a multiplier-type of effect in economic activity and thus overall tax collection.

- Argentina’s expected growth rate has already been reduced—and this does not take into account the renewal of the farm sector strike (see JP Morgan Research, by Florencia Vasquez—May 01, 2008: “2009 GDP forecast cut to 3% on mounting constraints”).

- In the mist of these inconsistencies, although within a small range, the domestic currency depreciated—despite central bank’s actions—i.e. there was small run against the peso, and is likely to continue, potentially accelerating. CD’s in pesos aren’t being rolled over and they are used buy dollars.

- Government expenditures are very high and are not decreasing. The amount of discretional redistribution from the poor to the rich has increased substantially, and it is expected to accelerate as the inflation rate keeps on increasing.

- Tax revenues increased; but this mainly explained by the inflation tax!

- Debt amortizations are very high and increasing for this year and the next ones—with very limited ability of the Argentine government to access international financial markets and at non-trivial high interest rate.

- Argentina’s national debt has not only increased in absolute volume (some estimates putting it close to US$ 200 billion) but it has increased as a percentage of GDP! Furthermore, this is a lower bound. If correctly computed, it is already in “Danger Zone” (see IDB’s report). No wonder that some other reports has estimated Argentina’s default probability to be the highest among emerging markets!!!

- Income distribution is deteriorating at an increasing rate (wasn’t this a “national and popular” administration?). For analysis I did early in 2007 see HERE (in Spanish).http://uoregon.edu/~magud/Redistribucion.pdf

- Price controls are still in effect. But they are totally ineffective.

- The latter, jointly with a (convenient) change in the measurement of the Consumer Price Index is the only inflation-reduction strategy of the administration!

- The number of bankruptcies is increasing.

- The housing market (one of the main engines in this “model’) is decelerating.

- Terms of trade bonanza is not such a thing, Jose Antonio Ocampo and Maria Angela Parra have shown. And the world economy is now slowing down.

- The Fed is already suggesting interest rate hikes could come sooner than expected to control U.S. inflation.

- The Euro area is slowing down.

- China and India are staring to be affected by higher inflation rates, which suggest that some decelerating of these overheating economies could be expected—and good for them. This, in turn, might impact on other parts of Asia.

- The commodities’ boom has slowed down in line with some small appreciation of the U.S. dollar. If the dollar continues to appreciate, this effect is likely to strengthen. The more so if the Fed increases interest rates and the economy, though slowly (as expected) progressively recovers some of its strength.

- Political acceptance of the five-month-old government is already very low (it looks more like a government about to finish its term in office, not an administration that has been in office for less than a year).

- The strategy of the current administration seems not to attack the source of the problems—the mismanagement of the macroeconomy—but to try to generate social tensions (e.g. t stimulate “class” divisions) to avoid the solution. Furthermore, I wouldn’t be surprised if the administration will eventually let things collapse and then blame “the market” for the problems (it is always “another one’s fault”).

Some Thoughts

The above were just a(n) (incomplete) list of facts. Interestingly, I would have written them in the early-mid seventies, most of them of have been true as well! (and a “funny” way to write a sad piece). So, we saw this picture, and how its ends. Would you put your money in Argentina? I won’t.

For a future posting: I am totally not surprised by the recovery of Argentina: the economy started from a huge collapse in 2001-2002 while its was favored by the so-called savings glut along with China and India (and the world economy as a whole) growing at high rates for a long time period—and the effects that these caused on commodities, the main source of exports in Argentina.

But now, in light of one of the worst macroeconomic admistration in Argentina’s history I am starting to think that the global context, instead of a blessing, it has been a curse. If so, the long-term costs of this will not be small.

Is the Party Over in Argentina? The Market Internalizes the Political Effects of Inconsistent Macro Policies (or vice-versa?)

This posting appeared in RGE-Monitor (Latin America) on April 23rd, 2008

The last couple of days financial markets in Argentina have shown capital flowing away from government bonds and into buying dollars (hoarding them, “jus in case”). This might seem at first glance controversial with the apparently sound macroeconomic figures: fiscal surplus, current account surplus, high growth rate, low official inflation rates, etc. I will argue that it shouldn’t.

Many commentators are suggesting that this is just a political problem—the government vs. farm producers conflict. In my opinion, if anything, the political frictions are just the trigger that shows how the market is internalizing the 5-year long macroeconomic mismanagement—with no long-term view. It clearly reflects the fact that, as I mentioned many times in my postings, even though the flow figures show an apparently solid economy the stock (i.e. intertemporal sustainability) show exactly the opposite.

The fiscal fragility is evident once one considers the heavy debt repayments due this and the coming years, the fragility on relying of very volatile (and temporary) sources of tax revenues to finance permanent expenditures. The former not only includes the export taxes, but also the inflation tax (this last one eventually decreasing as inflation gets out of controls—as it is currently happening—and the Olivera-Tanzi effect jointly with higher tax evasion and lower GDP growth).

Of course, decreasing government expenditures is political impossible for now, as it is appreciating the currency. On the latter, everyone would have expected the domestic currency to appreciate if let to float instead of depreciating[1]; unless this is the starting point of a standard textbook balance of payment crises… We can not rule out this happening (although with a low probability for now it is likely to increase over time). Why? The huge amount of debt needed to roll over in times of dry international financial markets (not to forget that Argentina has not even had a great amount of access to it in the so-called savings glut times) plus an election coming next year. Because let’s face it, the Kirchners receive political support due to the asymmetries in the tax revenue collection (mostly Federal) as opposed to the local (Provincial) expenditures that they manage to control the provincial and local governments.

By the way, the figures in the real side of the economy don’t look that promising either. GDP growth is decelerating as well as house sales, credit is still very limited, inflation is accelerating, provincial fiscal deficits are arising and increasing, lack of investment, energy shortages, wages indexations (although they are already running from behind to the inflation rate), ineffective price controls, increasing crossed subsidies to ineffectively trying to reduce price increases to middle-class, increasing income inequality (the more so the greater the inflation rate), lack of a nominal anchor, no long-term growth plans, lack of productivity-based wage increases, a reasonable exchange rate policy, serious anti-inflationary strategy, respect for the rule of law, etc. (the list can be extended as long as necessary, unfortunately).

It is true that there exist an international inflation problem. But Argentina’s inflation rate has dramatically separated from world inflation. Most of the other Latin American countries raised interest rates to try to reign in their inflation rates. Will Argentina be forced to do it in trying to stop a currency crisis? Hopefully the wrong macro-polices of the past will be recognized in a timely manner and the changes will be made. Even those that originally promoted the so-called “productive model” are now being cautious on reporting the need to correct the deviations. Aren’t they the smart ones that should have anticipated these effects?

The problem is that the longer it takes for corrective measures to be applied the greater the real effects and the more drastic adjustment would need to be. This resembles more and more over time the famous “war of attrition” of Alesina and Drazen (AER 1991): reforms are delayed until they are inevitable; but the costs of such lengthy wait are non-trivial. It also rings a bell in the credibility of inflation stabilization literature (Calvo and his co-authors have been teaching us this since the 1980s!)

Conclusion: I hear a tic-tac. Argentina is running out of time at an accelerating rate (as the inflation rate is clearly indicating). Things are still correctable. But the longer it takes, the greater the pain (i.e. real effects). Commentators presume it is just a political problem. If true, it is because the market is internalizing the huge macroeconomic mismanagement (that I have elaborated on in my previous posts). The market, being forward-looking, is signaling it. The political conflict is just the trigger of economic problems that the society in internalizing. Let’s hope that this time the government is able to interpret the signals and avoid repeating the same mistakes of the past.

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[1] And the central bank could be so creative as to claim responsibility for increasing exchange rate volatility on purpose to stop speculative capital flows.

The Short-Economics behind the Conflict Government vs. Rural Sector in Argentina

This post appeared in RGE-Monitor (Latin America) on March 31st, 2008.

Other than any political reasons—that I won’t discuss here—the conflict government-rural sector in Argentina results mainly from an economic inconsistency. Of course, there are additional important issues. I want to focus on what I understand is one of the basic origins of the problem.

As already reported before, Argentina has a high inflation bias generated by the over-use of the different policies (monetary, fiscal, and exchange rates) to keep demand higher than in equilibrium. Argentina also claims to be free of any effect of the current international financial crises due to strong fiscal and current account surpluses. I do not agree with this. Especially when dealing with the fiscal surplus.

The main source of the current primary surplus is essentially based on

1.The high prices of some of the key Argentine exports: soy, corn, etc. The problem is that these high prices are essentially temporary shocks. Even though there might have some permanent component due to the China, India effect (and thus related to the “decoupling” effect, something that I do not believe to exist), the speculative component is probably bigger. I see the latter as if a big share of the so-called savings glut was driven to commodities’ markets.

2. The increase in aggregate demand (through a standard multiplier process) derived from the consumption but mainly investment that the rural sector is generating—the sector internalizes that this is a transitory shock and thus invest now, anticipating the future correction (to long-run equilibrium prices) in commodities’ markets.

3.The inflation tax that result from (1) and (2) above plus the huge level of government expenditures (reflected, e.g., through VAT and profits tax revenues).

4. Although probably of second order, the consumption-credit expansion—as opposed to an investment—credit expansion.

The government tries partly to control the high inflation rate by an immense and increasing amount of crossed-subsidies. I would also expect that, unless the government seriously sits down to control inflation using the appropriate polices, these subsidies are likely to increase at an increasing rate.

A second element of the government inflation strategy is the flow primary fiscal surplus. The government is forced to have this surplus. The more so as time goes by. Why? Notice that Argentina was almost out of international financial markets in the last couple of years, when the global economy was expanding and there was plenty of international liquidity. Currently things in international markets are becoming more stringent and this phenomenon is likely to remain with us for some time.

Thus, for all of the above Argentina does not have other choice than keeping a high fiscal surplus—whether they like it or not. Then it either increases taxes or reduces expenditures. There is no doubt that the latter would be the sensible way to do it. It would increase the surplus at the same time that it would reduce the intertemporal fiscal fragility that I posted on several times before. It would contribute to reduce long-term inflation expectations. It would even contribute in a non-inflationary way to depreciate the real exchange rate. It would even potentially allow for expansionary fiscal polices if the international financial crises ends hitting hard on Argentina—something that although with still low probability can not be disregarded yet. Why not saving in good times for a rainy day?...And the list goes on.

But the latter would go against the whole economic philosophy of the Kirchners’ administration—and it would imply reckoning the multiple mistakes that they have incurred in. I would presume that the administration will not be willing to do it.

Therefore, the government is forced to increase taxes. Based on its (mis)understanding of the economy, it is then pushed into trying to increase export taxes further up. This is quite risky, though.For it is using transitory positive shocks to increase its permanent sustainability needs—and erroneously thinking that this will anchor inflation expectations.

So, this is my short-version of the economics that triggered the conflict. Let me conclude by highlighting that I think that this conflict is currently a political issue. But my understanding is that the roots of the problem lie on an incorrect reading of the economy, especially trying to sustain long-term growth based on temporary shocks—and without using them (or letting them be used) to invest in long-term productivity. As a result the administration prefers to increase taxes instead of reducing expenditures in still relatively (temporarily) good times—which it would allow for higher degrees of freedom if things get worse in the future. It thus implies that the government is not anticipating rainy days in the near future…

The Short-Economics behind the Conflict Government vs. Rural Sector in Argentina

This post appeared in RGE-Monitor (Latin America) on March 31st, 2008.

Other than any political reasons—that I won’t discuss here—the conflict government-rural sector in Argentina results mainly from an economic inconsistency. Of course, there are additional important issues. I want to focus on what I understand is one of the basic origins of the problem.

As already reported before, Argentina has a high inflation bias generated by the over-use of the different policies (monetary, fiscal, and exchange rates) to keep demand higher than in equilibrium. Argentina also claims to be free of any effect of the current international financial crises due to strong fiscal and current account surpluses. I do not agree with this. Especially when dealing with the fiscal surplus.

The main source of the current primary surplus is essentially based on

1.The high prices of some of the key Argentine exports: soy, corn, etc. The problem is that these high prices are essentially temporary shocks. Even though there might have some permanent component due to the China, India effect (and thus related to the “decoupling” effect, something that I do not believe to exist), the speculative component is probably bigger. I see the latter as if a big share of the so-called savings glut was driven to commodities’ markets.

2. The increase in aggregate demand (through a standard multiplier process) derived from the consumption but mainly investment that the rural sector is generating—the sector internalizes that this is a transitory shock and thus invest now, anticipating the future correction (to long-run equilibrium prices) in commodities’ markets.

3.The inflation tax that result from (1) and (2) above plus the huge level of government expenditures (reflected, e.g., through VAT and profits tax revenues).

4. Although probably of second order, the consumption-credit expansion—as opposed to an investment—credit expansion.

The government tries partly to control the high inflation rate by an immense and increasing amount of crossed-subsidies. I would also expect that, unless the government seriously sits down to control inflation using the appropriate polices, these subsidies are likely to increase at an increasing rate.

A second element of the government inflation strategy is the flow primary fiscal surplus. The government is forced to have this surplus. The more so as time goes by. Why? Notice that Argentina was almost out of international financial markets in the last couple of years, when the global economy was expanding and there was plenty of international liquidity. Currently things in international markets are becoming more stringent and this phenomenon is likely to remain with us for some time.

Thus, for all of the above Argentina does not have other choice than keeping a high fiscal surplus—whether they like it or not. Then it either increases taxes or reduces expenditures. There is no doubt that the latter would be the sensible way to do it. It would increase the surplus at the same time that it would reduce the intertemporal fiscal fragility that I posted on several times before. It would contribute to reduce long-term inflation expectations. It would even contribute in a non-inflationary way to depreciate the real exchange rate. It would even potentially allow for expansionary fiscal polices if the international financial crises ends hitting hard on Argentina—something that although with still low probability can not be disregarded yet. Why not saving in good times for a rainy day?...And the list goes on.

But the latter would go against the whole economic philosophy of the Kirchners’ administration—and it would imply reckoning the multiple mistakes that they have incurred in. I would presume that the administration will not be willing to do it.

Therefore, the government is forced to increase taxes. Based on its (mis)understanding of the economy, it is then pushed into trying to increase export taxes further up. This is quite risky, though.For it is using transitory positive shocks to increase its permanent sustainability needs—and erroneously thinking that this will anchor inflation expectations.

So, this is my short-version of the economics that triggered the conflict. Let me conclude by highlighting that I think that this conflict is currently a political issue. But my understanding is that the roots of the problem lie on an incorrect reading of the economy, especially trying to sustain long-term growth based on temporary shocks—and without using them (or letting them be used) to invest in long-term productivity. As a result the administration prefers to increase taxes instead of reducing expenditures in still relatively (temporarily) good times—which it would allow for higher degrees of freedom if things get worse in the future. It thus implies that the government is not anticipating rainy days in the near future…

Sound Macroeconomic Policies: Better Hurry or it will be TOO Late (or how Fiscal, Monetary, and Exchange Rate Policies are Running Behind the Curve)

This post appeared on RGE-Monitor on March 22nd, 2008.

I always tell my students: “If you observe inflation picking up, something is wrong with that economy; it is like a fever.”

The Argentine government has a high inflation problem. Instead of applying sound macroeconomic polices to stabilize inflation it is just using income polices—like price controls and export constraints.

On the contrary, since this is a long-run inflationary problem, the government should recognize its irresponsibility in conducing macroeconomic policy and work to correct its mistakes. For the longer they take to put things in order, the larger the correction will be. Among those problems is the simple fact that the administration has used these ineffective macroeconomic policies while the economy was still in a reasonable growth path. By avoiding the right policies in “good” times the government led the country’s inflation rate to separate—from above—from the international inflation rate. Yes, inflation rates have been higher the last year in most countries; but Argentina’s has been even higher. The problem then becomes: What will happen when things get worse (e.g. a negative external demand shock? By the way, the latter looks more likely as the international financial crisis is developing…

The true problem is that the government did not control inflation during the global expansion. Now that things are looking gloomy, will the government have some, if any, room to put the economy back in the right path? I have my doubts, unless the administration is willing to press the brakes quite abruptly—and the longer they take, the more abrupt the stop will need to be. In other words, Argentina decided not to correct the imbalances by using the correct policy toolkit when it was feasible to put the economy in a low volatility long run growth path with minor—may be no—real effects. To do it now, the adjustment will probably not be as smoothed as it could have been if the authorities would have understood the problem correctly. Argentina, one more time, chose a business cycle with potential big amplifications instead of a smoother path; it chose short run high growth rate levels instead of a longer horizon low volatility path—as. e.g. Brazil did.

Let me be slightly more specific. By sound macroeconomic policy I mean, among other things:

n letting the currency float

n a central bank devoted to truly control inflation—which now implies applying a contractionary monetary policy which ill appreciate the currency and reduce the excess aggregate demand

n a strong contractionary fiscal policy to reduce aggregate demand—and partially helps in controlling the real exchange appreciation so as not hurt exporters.

Notice that, as I mentioned in several previous postings, it does not imply a reduction in the growth rate of government expenditures—to rates lower than the tax revenue—but an actual targeted reduction. This is non trivial. Why? Because tax revenues, based especially on exports taxes and inflation taxes are the first ones that could be affected. For if external demand contracts plus, as likely, commodities’ prices lower returning to fundamental—instead of its high speculative component derived form the flows that are trying to avoid losses in other financial markets, the previously so called “savings glut”—export tax revenues will contract. Since also exporters’ income will be lower, so will aggregate demand—through the standard multiplier process. Note that the two main sources of aggregate demand impulses have been government expenditures and exporters high transitory incomes!

This is precisely the point to consider the need for a reduction in expenditures. Tax revenues are likely to be reduced. The government seems to ignore and thus fail to internalize this fact. If so, fiscal sustainability will start flashing a red light. On the contrary, reductions in public expenses will not only generate a flow fiscal surplus today, but also will be able to keep in “bad times.”[1]

Another thing to add is that an inflation target would have been a much better tool to provide the central bank with for it to focus on inflation. Problem is that inflation targets should be implemented in good times, not bad times—and I hear a tic-toc here…

Also note that since one of the main tools that the government has been using to control the inflation rate is subsidies—with no mayor effect—, as the inflation rate remains out of control, the amount (volume and quantity) of subsidies keeps on increasing. And it will rather continue growing the way things currently look. If so, they eventually—in the limit—become unmanageable, thus potentially reaping up the entire tax revenue. Again, the longer it takes for these subsidies to be removed, the greater their inflationary impact when liberalized.

Finally, what if the external demand shock ends up generating a stagflation-like situation? What will the government do in such a case? What if, on top of it the primary balance, it shows a deficit? What about the provincial governments’ deficit?

One more thing. Argentina did not had it easy to get international financing in global capital markets in these “good times.” Will it get it in the future if the situation becomes gloomier, as I presume? I doubt it. In this case, everything that I mentioned above can only get worse. As an example of this, FDI increased substantially in the later times in Latin America. But in Argentina? Hmm…

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[1] On the contrary, the government is seriously considering increasing its debt in almost U$S 4billion to finance a “bullet train” whose profitability analysis looks rather nonprofitable.

Argentina’s Way of Putting a Cap on Inflation: High Inflation ruled–out by Definition?

The following piece appeared in RGE-Monitor (Latin-America) on Mar 7, 2008

Argentina’s authorities are working on the design of the new Consumer Price Index—as if the previous one had problems, other than its “ex-post editing”.

The (almost official) information available (clarin) suggests that some elements of the new computation of the CPI could include:

1. Seasonal products: only the cheapest will be considered
2. Not computing
1. goods that experience price increases greater than 15% (assuming people won’t buy them)
2. health insurance payment other than “co-payments” (which are relatively few)
3. travel abroad
4. Private education expenses
3. Lower number of consumption goods in the consumption basket: it will be mostly focused on the basket of goods and services of lower-middle class families which:
1. could potentially be modified at discretion
2. it will be mainly based on food prices that are in one way or another under price controls
4. The weights in the consumption basket could be modified on a monthly basis
5. Giving more importance to the goods sold by supermarkets (as opposed to small stores). The latter, in turn, could be based on price-controlled goods and could be based on the reported prices rather than the true selling prices.

If the information above is true (to be seen) not only Argentina will increase the degree of default on its debt (a huge share of the debt is indexed by CPI). Argentina, by definition, will be ruling out high inflation—not least hyperinflation. Why? See (2)(a) above!—and not taking into account that the faster prices rise, the more (instead of less) of the goods would be purchased. The more so if one takes into account that for this methodology to be viable we would need to know the price elasticities of these goods. This is an experimental methodology in the U.S. where the amount of information and consumer surveys can support it. Because of this, this price index is reported along with a regular CPI, PPI, core inflation, etc. In Argentina, on the contrary, the plan seems to be to report this new index as the only CPI…

Some long-run implication of the above: around 50% of the pension funds firms’ assets are indexed by CPI. Then, the default also affects future retired people. On the contrary, instead of letting these firms (AFJP’s) invest their funds freely to maximize the expected profits of its to-be-retired people, the government wants AFJP’s to finance investment. It is the government’s role to set up the long-run institutions and sound macroeconomic policy for investment to increase, not force it. This partly results from the decrease in FDI that Argentina is experiencing—as opposed to our neighbor countries.

Actually, the opposite is being done. Argentina’s inflation is separating more and more from international inflation. This strongly reduces the incentives for long-term investments.

So far, consumption has been growing. This is partly due to the expansionary policies of the government and the crossed subsidy system—so people are paying for the higher prices anyway. It is also resulting (more and more over time) from the acceleration of the inflation rate. Argentines are unfortunately very knowledgeable of high inflation. When it accelerates, demand for goods increase to anticipate future higher prices, reducing the demand for money.

We also have to hope that commodities markets continue as they are. However, the debate has already started: is this a long-term effect or just a bubble where the savings glut has been propelling commodities’ prices (see RGE-Monitor, March 6^th)? If the latter were the case: will that be a yellow light, or a red light altogether?

However, could stagflation be knocking Argentina’s door in 2009? This is cannot be ruled out—and it’s in part conditional on commodities markets and the global effects of the current U.S. recession/slowdown. If so, we have to start internalizing a big future problem. For 2009 is an election year. This government is extremely biased to pump up aggregate demand through fiscal policy; the more so with a faltering consumption. But with high inflation already in place…

Argentina’s authorities would claim that the recent economic growth has not been seen for 100 years. This is not false. But it is also true that the rest of the world economy has been growing at high rates for last 5 years (say the China-India effect if you want to). On the contrary, I would claim that Argentina the later has helped Argentina grow despite the highly mismanaged macroeconomy. Argentina has been in front of a once-in-every-100-years chance to make a big step to long-run growth. We could be missing the opportunity, though.

Argentina 2008: Is the (already High) Inflation Rate Accelerating?

The following piece appeared in RGE-Monitor (Latin-America) on Feb 17, 2008

This is not a technical article. It just puts together some commonly known facts and asks some questions; it also includes some thoughts.

Facts (or, shall I say, Problems?):

1. Argentina’s “un-edited” (i.e. true) 2007 annual inflation rate is in the 20-25% range.
2. Wage contract negotiations are presently taking place. It looks like unions are requesting wage increases starting at 30% and up.
3. Although claiming that the latter contract renewals might be biannual, unions are requesting to being able to renegotiate them every six months.
4. As the piece by Mark Turner (here) pointed out, the current account surplus results from (the still high) external demand; it is not due to the artificially undervalued currency.
5. Jose Antonio Ocampo (here) highlights how the mentioned surplus is mainly due to capital flows instead of a trade surplus.

Given all of the above, Argentina’s authorities should be really worried (although the claim not to be.) Why? Well, not only the inflation rate is high, but it looks likely to accelerate. This can be seen by facts (1) and (2). Together they imply that unions are probably observing a reduction in the purchasing power of wages (past and future.) Since any wage negotiation in the context of an inflationary process should be both backward- and forward-looking, this means that: (i) not even “official” unions believe in the massaged official inflation rate—they understand that the true inflation rate experienced by workers have been higher that the government’s figure; (ii) they anticipate a high inflation rate for this year (probably not lower than last years’; my “gut feeling” guess in the 35-40% range); and (iii) there are reasonable chances to expect the inflation rate to accelerate, which generates the need to have a sort of “escape of clause” to re-negotiate every six months.

You do not need to be an economist to realize that a higher frequency of contract renewal is based on an expected increase in the rate of change of prices. Unions sit at the negotiation table trying to recover the lost purchasing power due to past inflation (the backward-looking component) and taking into account their expected inflation (the forward-looking component.) And like I said, the faster they expect inflation to increase, the sooner they would like to renegotiate.

Thus, and contrary to the administration’s intentions, inflation expectations are not being anchored. The more so if (as analyzed in my January 29^th) we also consider the potential (intertemporal) fiscal fragility of the government.

The academic literature has shown that inflation reduces long-term growth. Even though the global economy has been growing at high rates during the last years, things seem starting to change. We could expect the “tail wind” (i.e. external demand boom) that Argentina enjoyed to slowdown (in the best case scenario.) The administration is currently trying to engineer lower borrowing rates for long-term investment projects (especially if they are export-oriented.) This is not wrong, but it arrives late. This should have been the engine of growth instead of domestic consumption in the very recent past if the goal was long-term growth. They are also differing things in the expectation of a better second half of 2008 (shouldn’t they be planning and applying contingency plans ex-ante instead of acting ex-post?)

Lower, non-increasing, and credible inflation, as opposed to the current policy, will boost long-term growth since it stimulates longer horizon investment projects and increases the expected real rate of return on those projects. Current investment is mostly driven by short run expected sales rather than long run demand. It also improves income distribution (more here). As mentioned above, the piece by Mark Turner shows how we should have expected the same current account surplus regardless of the exchange rate. The difference being the non-trivial point that Brazil obtained it at the same time that its central bank was able to dominate the domestic inflation rate (and with no observable drawbacks in terms of growth; on the contrary, but based on higher productivity instead.) Or, as the piece by J.A. Ocampo highlights, that the accumulation of reserves is mainly borrowed (and thus more unstable since as easy as they entered the country, they can leave it; and capital controls never work.) The more so in the Argentine case in which close to half the international reserves are reduced by the central bank’s domestic liabilities (NOVAC, LEBAC, etc.) And praying for the commodities’ high prices not to be the next bubble to explode…

So far what the government is doing is clearly not going to control inflation. It does not anchor inflation expectation neither with its monetary policy, nor with its exchange rate policy or its fiscal policy. On the contrary, it looks more likely to make it get worse—inflation seems to be accelerating. The median voter seems to be happy with this policy, though. But it’s the policy maker’s role to appropriately consider and internalize the future effects of the current policies and adjust its present behavior accordingly—something not seen yet with the current administration.

It could be much better if the government would focus on reducing government expenditures (not just reduce the rate of growth to be lower than the growth rate of tax revenues—which are just casually high do the unusually high commodities’ prices) to achieve not only a higher and stronger primary fiscal surplus but also to enhance its sustainability. It should also let all relative prices be really free to adjust to equilibrate demand and supply (i.e. eliminate all the price controls and any type of capital controls) and let the exchange rate float. If relative prices are let to adjust, as well as the exchange rate, they will stop the growth rate of prices (i.e. inflation) and contribute, together with a non spurious fiscal surplus to contain inflation expectations—and thus wage negotiation adjustment (in quantity and frequency.) Core inflation would then be tackled with an inflation targeting regime, letting an independent central bank focus on its only goal: to preserve the value of the (domestic) currency. As of now, it will probably be better to raise interest rates to control the inflation in the short run while the rest of the reforms are put in place (including property rights that we could believe in—i.e. proper long-term institutions.). The question is, will this government be interested in implementing these and thus pursuing long-term and sustainable growth? I truly hope it. Unfortunately, I still have my doubts.

Es el Momento de un Fuerte Ajuste Fiscal

La situación financiera y productiva internacional no pareciera ser la más promisoria para el 2008. Estados Unidos es muy probable que entre en una situación recesiva. Sus mercados crediticios, en conjunto con los hipotecarios, probablemente forzarán a la Reserva Federal y al gobierno a bajar las tasas de interés en el corto plazo y a paquetes de estimulo fiscal, respectivamente. Ambos, si bien suavizarán los efectos recesivos del ciclo americano, propiciarán una suba mayor en la tasa de inflación—que de por sí ha subido producto del incremento del precio de las commodities. Sumada a la depreciación de dólar que se viene dando –y debería continuar por un tiempo—para corregir los desbalances comerciales, llevarán en el mediano plazo a una suba posterior en los tipos de interés. Esto último será para disminuir los efectos inflacionarios de las políticas de suavización del ciclo económico arriba mencionadas.

A su vez, esto impacta en la economía mundial. La apreciación del euro y la libra esterlina—y en parte del yen—tenderán a reducir el ritmo de crecimiento de Europa y el sudeste asiático. Esto podría generar una reducción en el ritmo de crecimiento de la economía china. Vale la pena mencionar que esta última viene mostrando un progresivo deterioro en su saldo comercial, producto de la inflación interna y la devaluación del dólar. Si finalmente el euro y la libra también corrigen sus valores hacia valores de equilibrio es esperable una caída más marcada del saldo de cuenta corriente chino—más aun si los precios de las commodities continúan en los altos valores registrados últimamente.

Argentina genera una parte sustancial de sus recursos fiscales en base a retenciones a las exportaciones. Si como consecuencia de lo anterior se observa una reducción en las exportaciones, la recaudación se verá afectada en forma importante. Por otra parte, como consecuencia del (des)manejo estadístico (léase INDEC), Argentina ha visto reducida su credibilidad. Asimismo, la tasa de inflación domestica se encuentra en valores cercanos a tornarse inmanejables. Se debe agregar que las necesidades de financiamiento externo son cada vez más altas y, peor aun, crecientes en el tiempo.

Así las cosas, una fuerte reducción del crecimiento del gasto público es imprescindible para solidificar la situación fiscal presente y en especial la futura. Y debe llevarse a cabo rápidamente—es el momento justo. Se sugiere que luego de las elecciones la tasa de crecimiento ha bajado al 35 %. Ahora, si la economía crece al 8.5% y la tasa de inflación (oficial) ronda el 8.5%, el gasto ha crecido mucho más de lo económicamente deseable. Tomando una medida inflacionaria un poco más realista, digamos 22%, todavía el incremento del gasto público es superior al producto—es decir que la participación del gasto público a producto se ha incrementado. Es verdad que el aumento en la recaudación se encuentra en el orden del 33%. Pero además de las exportaciones, una buena parte de dicho incremento es puramente precios (IVA, por ejemplo).

Si se analiza la situación intertemporal, la situación comienza a lucir más complicada aun. Un ejemplo sería la contabilización de los traspasos jubilatorios que son stocks, no flujos. Peor aun dado que dichos stocks son contabilizados solamente como activos presentes, sin incluir las obligaciones futuras que generan—no menores y crecientes en el tiempo. Probablemente la situación fiscal presente no resista un análisis de sostenibilidad intertemporal—que es tan importante como el flujo que representa el balance fiscal. Al fin de cuentas, este último es una medida de liquidez, pero no de sostenibilidad. Y eso si es que se lo computa debidamente. Pareciera entonces que, probablemente, Argentina presente en la actualidad una situación de fragilidad fiscal intertemporal, asumiendo que el superávit primario que se informa estuviese bien computado...

Bajando el gasto público se contribuye a no seguir generando presiones inflacionarias por el lado de la demanda. Dada la alta recaudación fiscal, se tiende a incrementar el ahorro público (al menos temporalmente, hasta que la inflación se reduzca a valores más razonables—en línea con la tasa de inflación internacional). El incremento en el ahorro público se puede utilizar para comprar divisas en el mercado de cambios—ayudando a mantener el tipo de cambio sin forzar la emisión (inflacionaria) del Banco Central (siguiendo los lineamientos del gobierno). De hecho liberar el tipo de cambio y dejar que el Banco Central se concentre en el control de la tasa de inflación es aun mejor. Si la autoridad fiscal realmente quiere mejorar el tipo de cambio lo debe hacer ahorrando en dólares. Estos, a su vez sirven para constituir un fondo fiscal anti-cíclico. Este último es imprescindible establecerlo y YA, pues cuando la economía deje de crecer tan rápido (y asumiendo que no comience a caer), será muy tarde—y políticamente más complicado. También se puede utilizar parte del ahorro fiscal para reducir el endeudamiento si así se lo desea—por el momento se vislumbra un aumento en el nivel de endeudamiento, por el contrario.

Las consecuencias de una marcada estabilización fiscal no podrían ser mejores. Se lograría disminuir las presiones y expectativas inflacionarias. Se permitiría al Banco Central efectivamente cumplir su rol (mantener el valor de la moneda). A su vez, la reducción de la tasa de inflación permitirá bajar las tasas de interés para proyectos productivos (i.e. estimular la inversión). En la medida que la inversión crezca a costa del consumo sus efectos sobre la tasa de inflación se verán fuertemente reducidos—asimismo, mayor inversión conduce a menor tasa de inflación futura debido a que implica una mayor oferta de bienes futuros (cuando maduran las inversiones). De este modo contribuye a anclar las expectativas inflacionarias. Menor fragilidad fiscal genera una mayor entrada de capitales de largo plazo. A su vez, estos últimos, en conjunto con un tipo de cambio libre reducen más aun las presiones inflacionarias y contribuyen a incrementar la tasa inversión.

Por otra parte, la literatura académica ha demostrado que las disminuciones de gasto público son claramente expansivas en términos de producto. Por lo cual no solamente se logra que la economía crezca más rápidamente, sino que se aumenta la recaudación y por ende se contribuye a consolidar el saldo fiscal más fuertemente. De esta manera potencia todos los efectos aquí descriptos.

Existen motivos adicionales por los cuales ahora es el momento de reducir el gasto público fuertemente. Como consecuencia de la regulación de precios, muchos precios relativos se encuentran desfasados (e.g. combustibles, energía, alimentos, entre muchos otros). Cuanto más se frena el ajuste de precios relativos, más fuerte reaccionan (inflación reprimida). Durante 2008 es muy probable que varios de estos precios se corrijan (al menos parcialmente)—algunos ya han comenzado. Dichos ajustes tienden a incrementar las presiones inflacionarias. Más aun si el tipo de cambio se ata a una moneda que se esta depreciando (por ahora el dólar, pero en el corto plazo el euro, cuando tienda a retornar a un valor de equilibrio de largo plazo). Con el tiempo, esto a su vez permitirá disminuir las presiones tributarias, liberando fondos adicionales para la inversión (en capital físico—infraestructura—y humano—salud, educación, investigación científica) y el consumo. Nótese que esto último recién ocurrirá una vez que la tasa de inflación se estabilice en valores “normales”. Esto implica que la baja en el gasto público permitirá la creación de recursos extraordinarios por un periodo limitado. Dichos recursos pueden ser extremadamente útiles para solidificar la fragilidad fiscal de largo plazo—a lo cual parece destinada Argentina de no mediar correcciones inmediatas.

La historia argentina está llena de episodios de ajuste fiscal. Mayormente dichas correcciones fueron el resultado de excesos durante los tiempos de expansión. Si el gobierno tuviera una visión keynesiana del mundo, precisamente ahora, que todavía la economía está creciendo fuertemente, debería re-balancear las cuentas públicas en lugar de verse forzado hacerlo cuando “los números ya no cierren”.

Otros puntos que contribuyen en la discusión son los siguientes. ¿Qué pasa con los desbalances fiscales provinciales? Se comienza a notar que a pesar del crecimiento agregado, ciertos distritos muestran déficit en sus balances fiscales. Dado que de una forma u otra el gobierno nacional termina absorbiendo dichos déficit (es como un “pagador de última instancia”) se torna importante seguirlos de cerca. A menos que las normas tributarias se modifiquen (ley de coparticipación sumado al hecho que buena parte de la recaudación nacional proviene de recursos no coparticipables), los balances fiscales provinciales deben ser incluidos en el análisis de fragilidad fiscal (tanto en el flujo como en el stock intertemporal).

Relacionado con lo anterior están los fondos fiduciarios. Contadas inversiones y gastos públicos se financian con dichos fondos. Por lo tanto deberían formar parte del estudio de los ingresos y gastos públicos nacionales. En especial si de aquí también el gobierno nacional termina siendo el garante y “pagador de última instancia”.

En términos de gastos, los subsidios cruzados, que no son otra cosa que una redistribución de ingresos desde los pobres hacia los ricos, juegan un rol importante. Por un lado, sus efectos sobre la contención de la tasa de inflación son limitados y pierden efecto con el paso del tiempo. Si en realidad se permitiera a los precios relativos ajustar en equilibrio, dichos gastos se deberían reducir. Queda la duda si desafectar dichos gastos es políticamente posible. Son gastos muy fáciles de establecer, pero pareciera mucho más complicado suspenderlos.

Si de competitividad se trata, bajar el gasto público contribuye a depreciar el tipo de cambio real sin generar presiones inflacionarias—por el contrario, las baja.

Finalmente, no sólo es necesario disminuir el gasto público y balancear las cuentas fiscales por sus efectos de corto y largo plazo. La composición del mismo es fundamental. Se debe dedicar una mayor proporción del presupuesto para salud y educación: mayor capital humano genera mayor crecimiento presente y futuro, mayor productividad, y por ende menor inflación y mayor recaudación. Es importante, que no se vea esto como un aumento del nivel de gasto per se (por ejemplo incrementar el gasto en personal). Se requiere mayor productividad en el gasto en todos los rubros. Pero si de crecimiento—y en especial de desarrollo de largo plazo—se refiere, la educación, la salud, y la investigación científica son fundamentales. Sin estos, se torna mucho más difícil sostener niveles de productividad de largo plazo como los que Argentina necesita en la actualidad.

Nuestro país se encuentra en un punto de inflexión que difícilmente se vuelva a repetir por un largo tiempo. Esperemos que las autoridades sinceramente busquen implementar las políticas necesarias para que Argentina pueda dar el salto que requiere. La oportunidad es ahora; mañana puede ser tarde.