The following appeared on RGE-Monitor, on February 2, 2009.
As is widely known, Keynes posed that “in the long-run we are all dead”, as well a role for counter-cyclical fiscal policy.
In Argentina, the statement that in the long-run we are all dead is a way of living for many people. Uncertainty reigns. Thus, when a negative shock hits the median citizen the more likely response is to increase expenditures instead of saving. Why? Well, since this median citizen is not sure if he/she will be able to spend in the future—due to the effects of the shock—then he/she will choose to consume today while he/she can. That is one way of thinking that in the long-run we are all dead. Any standard model in economics that you use to rationalize your “optimal” behavior, on the contrary, will generally make you choose to “save for a rainy day: in response to temporary positive shocks. In other words, you need to smooth your consumption intertemporally so as to maximize your utility.
Basic political economy models teach us that, under normal circumstances, the median voter preferences are reflected in the elected government. Following this reasoning, then, an elected government is likely to also live by the rule of in-the-long-run-we-are-all-dead. Examples of this could be increasing expenditures (many times irresponsibly from an intertemporal sustainability perspective) to win elections and increase power, discretional redistribution, inflation-prone expansionary policies, disrespect for the rule of law (i.e. weak property rights), price controls, (recent) debt swaps at high interest rates (the next government, hopefully, will deal with it…), etc. The list can be long, but there is a word that summarizes this behavior: populism.
Of course, populism hides behind Keynes since he was the one that advocated increasing government expenditures to smooth out a recession to offset the effective demand problem. However, Keynes prescription also includes reducing public expenditures in “good times.” This is the part that populists seem to have missed. Alternatively, we can describe populists as Keynesians that misunderstood Keynes—or, I shall say, that interpret it in a biased way so as to falsely (and purposely) believe that they were supported by some degree of intellectuality. Thus, since in the long run we are all dead, let’s spend now; the next one will pay… (if lucky).
I believe this a good simplification of Argentina (and some other Latin American countries) in the 2000’s. The uninterrupted populist governments since 2001 (and the private sector as well) spent irresponsible, without any care for the repayment time. Instead of taking advantage of the external boom to improve the long-term growth and sustainability of the economy, expenditures ballooned—in good times! Now, that the world economy is in a cleansing mode, the government wants to recall that they praised to be Keynesians. Too late. Good times should have been used to accumulate for bad ones—this goes back to biblical times. (Another way to put it is that the government should have built a anti-cyclical fiscal fund instead of increasing expenditures and then appropriating private sector’s savings—AFJP’s fund—instead.)
So, what happened? A rational model of intertemporal optimization might suggest that the median Argentinean has a discount factor that is way too small (a high discount of the future, in the limit converging to zero).[1] The more so for the government, since they will not be in office when the time to pay for the excesses finally comes. The median voter will be there, though. Hopefully, he/she will be more forward-looking next time and decide based on what has been learnt. Otherwise, unless extreme luck hits the country, it will be difficult. Some extreme luck impacted Argentina between 2002 and H1 of 2008, but it was not internalized. Let’s hope that eventually the median voter will increase his/her discount factor and vote accordingly—and rationally, not only according to economic and political economy models, but also in an intertemporally social way.
[1] As in any basic intertemporal optimization model, the ratio of the marginal utility of present consumption to the marginal utility of future consumption equals the gross interest rate times the discount factor. If the latter is less than one, with a concave utility function, consumption decreases over time. The smaller the dis
Monday, February 2, 2009
On the distributive effects of terms of trade shocks: the role of non-tradable goods
The following appeared on RGE-Monitor, on January 10, 2009.
In a recent paper(http://www.uoregon.edu/~magud/goodnews-tot-shock-01-06-09.pdf), jointly with Sebastian Galiani and Daniel Heymann, we analyze the effects of the 2008 commodities’ price spikes on income distribution. We mainly focus on resource-rich economies (especially those related to foodstuff) but our analysis is general enough to encompass a broader set of economies—as shown. We put special emphasis on the role played by the non-tradable sector. Since in one way or another the reaction of governments has been tariffs, export taxes, or quantitative restriction (just to cite a few), we incorporate this into the analysis. Importantly, the model is able to explain the implications of the distributive tensions observed. Among the most salient ones is the redistributive conflicts between urban labor (skilled vs. unskilled), as opposed to the traditional study of tensions between landlords and urban labor. A summary follows.
An improvement in international terms of trade clearly benefits the representative agent of a small open economy. Higher returns for the exportable sector and an increased aggregate spending capacity in terms of traded goods are likely to encourage economic growth. However, this does not imply that every group in a society is necessarily made better off.
The potential for distributive impacts of changes in international prices has been traditionally recognized in the literature, at least as far back as the Stolper-Samuelson theorem (1941). In turn, those distributive impacts may trigger social conflict, which could be deleterious for economic growth (see, among others, Rodrik, 1999). A recent instance of the tensions that can be generated by large shifts in world prices occurred in early 2008, following a sharp rise in the prices of commodities--and food in particular. This lead to social and political unrest in a large number of developing countries (with riots in some 30 cases), and to policy responses in the form of subsidies, price fixing, and export restrictions. Such reactions were observed both in food importers and in economies that export commodity foodstuffs (see The Economist, 2008).
To explain the emergence of those types of events we introduce non-tradable goods to an otherwise standard neoclassical trade model, in the Heckscher-Ohlin-Samuelson (HOS) tradition. This allows us to study the distributive effects of terms of trade shocks for a wide arrange of configurations.
We show that in a two-sector economy (comprised of exportable and non-tradable goods) there are no redistributive effects of external terms of trade shifts since relative prices remain the same. This neutrality implies the non-existence of Stolper-Samuelson effects in this set up.
By extending the model to the domestic production of manufactures, distributional tensions arise. Conditional on factor intensities, some income earners benefit at expense of the others in response to the terms of trade shock. Interestingly, important distributional conflicts arise within urban labor (skilled vs. unskilled) as opposed to the “traditional" rural vs. urban factors disputes.
Then we analyze the implications of export taxes as a mechanism to re-distribute the effects of external shocks. We find that the ability of the government to cushion the impact of the terms of terms shift on the economy's income distribution depends not only on how it re-distributes the revenues, but also in how much it “saves." Conditional on factor intensities and market shares, interesting alliances among different income groups might arise. Again, the center of the distributional tensions and gains and losses resulting from the income redistribution policy concentrate within urban labor. As an example, we show conditions in our benchmark model (that we may dub as a standard resource-rich economy) under which skilled (urban) labor favors landowners against unskilled (urban) labor regarding export tax policy.
The analytical framework can be used to describe the motivations and incentives of different groups in political economy games. In this connection, our arguments contribute to a broader literature that emphasizes the role of trade on domestic political cleavages and domestic policies and institutions (see, for example, Rogowski (1989)). Here, we specifically analyze the consequences of taxes on foreign trade on factor incomes—in the setups described above—to discuss the effects of international prices' shifts and income redistribution. The introduction of the non-traded goods in the analysis implies that foreign trade taxes need not imply protection of import-competing activities (since these may be economically insignificant, as in the two-sector case) and that their implications for factor prices may depend strongly on the use of the tax revenues, apart from the effect of policies on the relative prices of traded goods, which is the change on which the typical HOS analysis concentrates.
In a recent paper(http://www.uoregon.edu/~magud/goodnews-tot-shock-01-06-09.pdf), jointly with Sebastian Galiani and Daniel Heymann, we analyze the effects of the 2008 commodities’ price spikes on income distribution. We mainly focus on resource-rich economies (especially those related to foodstuff) but our analysis is general enough to encompass a broader set of economies—as shown. We put special emphasis on the role played by the non-tradable sector. Since in one way or another the reaction of governments has been tariffs, export taxes, or quantitative restriction (just to cite a few), we incorporate this into the analysis. Importantly, the model is able to explain the implications of the distributive tensions observed. Among the most salient ones is the redistributive conflicts between urban labor (skilled vs. unskilled), as opposed to the traditional study of tensions between landlords and urban labor. A summary follows.
An improvement in international terms of trade clearly benefits the representative agent of a small open economy. Higher returns for the exportable sector and an increased aggregate spending capacity in terms of traded goods are likely to encourage economic growth. However, this does not imply that every group in a society is necessarily made better off.
The potential for distributive impacts of changes in international prices has been traditionally recognized in the literature, at least as far back as the Stolper-Samuelson theorem (1941). In turn, those distributive impacts may trigger social conflict, which could be deleterious for economic growth (see, among others, Rodrik, 1999). A recent instance of the tensions that can be generated by large shifts in world prices occurred in early 2008, following a sharp rise in the prices of commodities--and food in particular. This lead to social and political unrest in a large number of developing countries (with riots in some 30 cases), and to policy responses in the form of subsidies, price fixing, and export restrictions. Such reactions were observed both in food importers and in economies that export commodity foodstuffs (see The Economist, 2008).
To explain the emergence of those types of events we introduce non-tradable goods to an otherwise standard neoclassical trade model, in the Heckscher-Ohlin-Samuelson (HOS) tradition. This allows us to study the distributive effects of terms of trade shocks for a wide arrange of configurations.
We show that in a two-sector economy (comprised of exportable and non-tradable goods) there are no redistributive effects of external terms of trade shifts since relative prices remain the same. This neutrality implies the non-existence of Stolper-Samuelson effects in this set up.
By extending the model to the domestic production of manufactures, distributional tensions arise. Conditional on factor intensities, some income earners benefit at expense of the others in response to the terms of trade shock. Interestingly, important distributional conflicts arise within urban labor (skilled vs. unskilled) as opposed to the “traditional" rural vs. urban factors disputes.
Then we analyze the implications of export taxes as a mechanism to re-distribute the effects of external shocks. We find that the ability of the government to cushion the impact of the terms of terms shift on the economy's income distribution depends not only on how it re-distributes the revenues, but also in how much it “saves." Conditional on factor intensities and market shares, interesting alliances among different income groups might arise. Again, the center of the distributional tensions and gains and losses resulting from the income redistribution policy concentrate within urban labor. As an example, we show conditions in our benchmark model (that we may dub as a standard resource-rich economy) under which skilled (urban) labor favors landowners against unskilled (urban) labor regarding export tax policy.
The analytical framework can be used to describe the motivations and incentives of different groups in political economy games. In this connection, our arguments contribute to a broader literature that emphasizes the role of trade on domestic political cleavages and domestic policies and institutions (see, for example, Rogowski (1989)). Here, we specifically analyze the consequences of taxes on foreign trade on factor incomes—in the setups described above—to discuss the effects of international prices' shifts and income redistribution. The introduction of the non-traded goods in the analysis implies that foreign trade taxes need not imply protection of import-competing activities (since these may be economically insignificant, as in the two-sector case) and that their implications for factor prices may depend strongly on the use of the tax revenues, apart from the effect of policies on the relative prices of traded goods, which is the change on which the typical HOS analysis concentrates.
Argentina’s crisis response: some likely effects
The following appeared on RGE-Monitor, on December 22, 2008.
1. Argentina’s economy is slowing down—a recession can not be disregarded for 2009. Data on this abound from any bank or investment-research firm (domestic or foreign).
2. The world economy is also slowing down with non-trivial chances of many developed and developing economies being in recession during most of 2009. The recovery, in the best case scenario, might not be observed until (probably H2 of) 2010. Regardless of the exact date that the world economy starts to recover it will be a very progressive increase in growth rates—specifically, below potential GDP. More likely the US will be the first economy to start the recovery phase thanks to its more developed financial markets and the willingness of the authorities to (rationally) act–even if with some mistakes on the way. Europe, Japan, and the rest of the developed world will follow suit but with lags. These lags will be more pronounced for developing nations, as their external and internal demands depend very heavily on the developed world’s real and financial sectors. The latter applies, for example, to China, India, Brazil, Russia, and SE Asia.
3. Back to Argentina: expenditures have been on the rise; tax revenues are going down and will probably continue on this trend—due to decreases in external and internal demand alike. The official response to the effects of the external crisis on the already prone-to-crises policy is more expansionary fiscal and credit policies. Note, however, that the (regressive) proposed policy distributes resources from poor to middle income and rich people. In the first place because it is mainly financed or leveraged from the recently nationalized pension funds, which are more relevant for retirement for lower income families. Other examples include tax reductions for middle to high income households, credit for cars and other durable goods (that only already credit-worthy individuals will be able to take advantage of, i.e. poor people less likely), etc.
It is worth mentioning that the higher the household’s income, the higher its marginal propensity to import. Why is this important? An explanation follows.
The deterioration in the external terms of trade (which is here to stay for some time) jointly with the decrease in investment, export infrastructure investment, and the instability of property rights is already worsening the (quantity and quality of) exports—not to mention that rural sectors are again in protest-mode. Imports, despite the economy’s slowdown, might tend to increase. This results from the appreciated real exchange rate and the right-hand-side tail of the income distribution’s higher marginal propensity to import—mainly consumption goods, though. Thus, the administration’s policy looks likely to worsen the (already decreasing) current account balance. The financial account is already looking gloomy, as the official data shows alarming levels of capital outflows—some even suggesting levels higher than in the 2001-2002 crisis (see INDEC’s Q3 figures for these and other related data).
The exchange and price controls/crossed subsidies that distort the entire vector of relative prices could exert domestic pressure on central bank’s reserves. People might start thinking about running against the domestic currency in expectation of a depreciation of the domestic currency—the more so if you factor in the deterioration of the fiscal accounts already mentioned and the industrial sector demands for a “competitive” exchange rate. In turn, this will contribute to further worsening the fiscal balance, as opposed to the administration intentions, as lower confidence in the government increase tax evasion and capital outflows. (The tax forgiveness to repatriate capital outflows recently passed for this purpose is not likely to work; only marginal effects may be seen as my previous post suggests.) All this will be exacerbated by the economy’s slowdown. Furthermore, this reduces the country’s availability of international credit. The more so if you take into account the increasing number of provinces moving into fiscal deficit—including the heavy weight province of Buenos Aires, which given its unskilled labor-intensive manufacture sector is likely to be hit the most as the crisis spreads into the country. Let’s also mention that for 2009 and 2010 the federal government’s fiscal needs are in the order to of $ 20b per year. Thus, the willingness to lend to Argentina looks strong in the downside risk. Consequently, at a minimum, the entire outlook signals caution.
1. Argentina’s economy is slowing down—a recession can not be disregarded for 2009. Data on this abound from any bank or investment-research firm (domestic or foreign).
2. The world economy is also slowing down with non-trivial chances of many developed and developing economies being in recession during most of 2009. The recovery, in the best case scenario, might not be observed until (probably H2 of) 2010. Regardless of the exact date that the world economy starts to recover it will be a very progressive increase in growth rates—specifically, below potential GDP. More likely the US will be the first economy to start the recovery phase thanks to its more developed financial markets and the willingness of the authorities to (rationally) act–even if with some mistakes on the way. Europe, Japan, and the rest of the developed world will follow suit but with lags. These lags will be more pronounced for developing nations, as their external and internal demands depend very heavily on the developed world’s real and financial sectors. The latter applies, for example, to China, India, Brazil, Russia, and SE Asia.
3. Back to Argentina: expenditures have been on the rise; tax revenues are going down and will probably continue on this trend—due to decreases in external and internal demand alike. The official response to the effects of the external crisis on the already prone-to-crises policy is more expansionary fiscal and credit policies. Note, however, that the (regressive) proposed policy distributes resources from poor to middle income and rich people. In the first place because it is mainly financed or leveraged from the recently nationalized pension funds, which are more relevant for retirement for lower income families. Other examples include tax reductions for middle to high income households, credit for cars and other durable goods (that only already credit-worthy individuals will be able to take advantage of, i.e. poor people less likely), etc.
It is worth mentioning that the higher the household’s income, the higher its marginal propensity to import. Why is this important? An explanation follows.
The deterioration in the external terms of trade (which is here to stay for some time) jointly with the decrease in investment, export infrastructure investment, and the instability of property rights is already worsening the (quantity and quality of) exports—not to mention that rural sectors are again in protest-mode. Imports, despite the economy’s slowdown, might tend to increase. This results from the appreciated real exchange rate and the right-hand-side tail of the income distribution’s higher marginal propensity to import—mainly consumption goods, though. Thus, the administration’s policy looks likely to worsen the (already decreasing) current account balance. The financial account is already looking gloomy, as the official data shows alarming levels of capital outflows—some even suggesting levels higher than in the 2001-2002 crisis (see INDEC’s Q3 figures for these and other related data).
The exchange and price controls/crossed subsidies that distort the entire vector of relative prices could exert domestic pressure on central bank’s reserves. People might start thinking about running against the domestic currency in expectation of a depreciation of the domestic currency—the more so if you factor in the deterioration of the fiscal accounts already mentioned and the industrial sector demands for a “competitive” exchange rate. In turn, this will contribute to further worsening the fiscal balance, as opposed to the administration intentions, as lower confidence in the government increase tax evasion and capital outflows. (The tax forgiveness to repatriate capital outflows recently passed for this purpose is not likely to work; only marginal effects may be seen as my previous post suggests.) All this will be exacerbated by the economy’s slowdown. Furthermore, this reduces the country’s availability of international credit. The more so if you take into account the increasing number of provinces moving into fiscal deficit—including the heavy weight province of Buenos Aires, which given its unskilled labor-intensive manufacture sector is likely to be hit the most as the crisis spreads into the country. Let’s also mention that for 2009 and 2010 the federal government’s fiscal needs are in the order to of $ 20b per year. Thus, the willingness to lend to Argentina looks strong in the downside risk. Consequently, at a minimum, the entire outlook signals caution.
On the contractionary effects of expansionary fiscal policy, sustainability, and income distribution in Argentina (cont.)
The following appeared on RGE-Monitor (Latin America) on December 12, 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 cancelling 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.
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 cancelling 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 appeared in RGE-Monitor (Latin America) on November 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.
The Argentine government finally found out that the international crisis will affect the country—the more so due to its poorly managed macroeconomy (although they will not recognize the latter). Good for them—better late than never.
In response to the expected increase in unemployment, worsening of the current account (to get even worse and affect the exchange rate), and thus fiscal stance (debt default possible?), the government apparently intends to increase public expenditure, unemployment subsidies, and protection (subsidies?, tax deductions?, closing the economy?) for inefficient sectors to smooth the volatility. In one way or another it implies a deterioration of the fiscal and the current account balances. And both could fall sharply…
Of course, I believe the argument would go, this is what developed countries (as well as Chile and Brazil among others) are doing to ameliorate the slump. However, in the above mentioned paper I show not only the asymmetric nature of business cycles, but also that counter-cyclical fiscal policy is only effective provided the level of debt to GDP is sufficiently low. Translating that from the model to every day economics it basically means that, all else equal, you can engineer standard Keynesian fiscal policy provided you can finance it.
Moreover, the transmission channel includes the fact that an increase in government expenditures increases the risk premium (think on the effects of Argentina’s country risk!). In turn, this generates a contractionary effect on output. Thus, unless the government has plenty of room to finance an increase in aggregate demand without affecting the interest rate much, that will be able to offset the mentioned contractionary effect, on the contrary, increasing government expenditures will end up being contractionary in terms of output.
To have a simple picture, compare the ability of the U.S. (or Chile and Brazil) to issue debt in order to finance government expenditures with that of Argentina. Consider not only the country risk differential, but the reputation of honoring debts, responsible intertemporal macroeconomics (U.S.) instead of pro-cyclical fiscal policy (Argentina), already high interest rates, higher unemployment, lower productivity, high default probabilities, a political administration highly dependent on unions, expectations of a depreciated exchange rate (the more so if the increase in government expenditures appreciates the real exchange rate), credibility of institutions(!), and the list, unfortunately, can grow longer and longer.
Notice also that Argentina has been manipulating the statistics and using creative accounting to show a supposedly strong fiscal surplus (the flow, not its sustainability though), financing increased expenditures based on temporary revenues that are now, as I posted on many times in this blog, decreasing: commodities’ prices have been (and will probably continue) contracting, as well as the VAT as the economy self-corrects the government’s pro-cyclicality. The economy is not only expected to suffer from lower international prices, but quantities produced and exported are also likely to keep on falling. I wouldn’t be surprised if this exerts pressures on the exchange rate with inflationary implications despite the expected lower domestic and foreign demand.
Now the administration wants to increase expenditures much more but, where will the financing come from? And, at what price? International financial markets are virtually closed and tax revenues will tend to contract. The nationalization of private retirement funds (AFJP), the government claims, will not be used to finance its expenditures. Will that still be the case? I do hope so.
Even if AFJP’s funds are used directly or indirectly (through financial intermediation, fiduciary funds, etc.), given all of the above, more likely the expansionary fiscal policy will end up being contractionary in terms of output. This will exacerbate the crises, especially given the “initial conditions” on which (and when) the policy is put to work. This just adds to worsen the overall situation, not only the real side of the economy, but could potentially be expanded to the monetary side—hopefully the increase in expenditures will not be monetized, because if it is, bye-bye…
Let me clarify that I do not necessarily mean that counter-cyclical fiscal policy is a bad thing; it depends. But in the case of Argentina, where the ‘good times’ had been wasted, it does not make much sense now. The more so since the government has been praising its policy of de-indebtedness since 2003, while the debt has actually increased. It can even be considered unfair for those (countries) that did behave “properly” and saved in good times for the bad times. But I guess the (sophisticated) market, unlike Argentina’s government, will internalize this.
To sum up, Argentina’s government put the country into an unsustainable path during the Kirchners’ administration. Now, the day of reckoning is approaching. The government, again, does not quite understand the sources of the problem and the way to address it. Furthermore, the economic crises-mode that the government put the country in can be compounded by the political crises that seems to be already in motion—which looks likely to worsen during the election year (2009).
The saddest part of this is the long terms effects. Poverty, if appropriately measured reached levels similar to the 2001-2002 collapse. Education and health did not improve in these years with all the supposed abundance. Thus, the correction that the economy will need to go through will only re-enforce this, worsening the country’s income distribution. But let’s be clear: it is not the market’s fault; it is solely the effects of the Kirchners’ administration that is forcing the market to internalize this mismanagement. Of course, we will see how this story ends as more information is made available—hopefully non-massaged data, though.
[1] “On Asymmetric Business Cycles and the Effectiveness of Counter-Cyclical Fiscal Policy,” Journal of Macroeconomics, Volume 30, Issue 3, September 2008, 885-908 and reproduced here with the author’s permission.
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.
The Argentine government finally found out that the international crisis will affect the country—the more so due to its poorly managed macroeconomy (although they will not recognize the latter). Good for them—better late than never.
In response to the expected increase in unemployment, worsening of the current account (to get even worse and affect the exchange rate), and thus fiscal stance (debt default possible?), the government apparently intends to increase public expenditure, unemployment subsidies, and protection (subsidies?, tax deductions?, closing the economy?) for inefficient sectors to smooth the volatility. In one way or another it implies a deterioration of the fiscal and the current account balances. And both could fall sharply…
Of course, I believe the argument would go, this is what developed countries (as well as Chile and Brazil among others) are doing to ameliorate the slump. However, in the above mentioned paper I show not only the asymmetric nature of business cycles, but also that counter-cyclical fiscal policy is only effective provided the level of debt to GDP is sufficiently low. Translating that from the model to every day economics it basically means that, all else equal, you can engineer standard Keynesian fiscal policy provided you can finance it.
Moreover, the transmission channel includes the fact that an increase in government expenditures increases the risk premium (think on the effects of Argentina’s country risk!). In turn, this generates a contractionary effect on output. Thus, unless the government has plenty of room to finance an increase in aggregate demand without affecting the interest rate much, that will be able to offset the mentioned contractionary effect, on the contrary, increasing government expenditures will end up being contractionary in terms of output.
To have a simple picture, compare the ability of the U.S. (or Chile and Brazil) to issue debt in order to finance government expenditures with that of Argentina. Consider not only the country risk differential, but the reputation of honoring debts, responsible intertemporal macroeconomics (U.S.) instead of pro-cyclical fiscal policy (Argentina), already high interest rates, higher unemployment, lower productivity, high default probabilities, a political administration highly dependent on unions, expectations of a depreciated exchange rate (the more so if the increase in government expenditures appreciates the real exchange rate), credibility of institutions(!), and the list, unfortunately, can grow longer and longer.
Notice also that Argentina has been manipulating the statistics and using creative accounting to show a supposedly strong fiscal surplus (the flow, not its sustainability though), financing increased expenditures based on temporary revenues that are now, as I posted on many times in this blog, decreasing: commodities’ prices have been (and will probably continue) contracting, as well as the VAT as the economy self-corrects the government’s pro-cyclicality. The economy is not only expected to suffer from lower international prices, but quantities produced and exported are also likely to keep on falling. I wouldn’t be surprised if this exerts pressures on the exchange rate with inflationary implications despite the expected lower domestic and foreign demand.
Now the administration wants to increase expenditures much more but, where will the financing come from? And, at what price? International financial markets are virtually closed and tax revenues will tend to contract. The nationalization of private retirement funds (AFJP), the government claims, will not be used to finance its expenditures. Will that still be the case? I do hope so.
Even if AFJP’s funds are used directly or indirectly (through financial intermediation, fiduciary funds, etc.), given all of the above, more likely the expansionary fiscal policy will end up being contractionary in terms of output. This will exacerbate the crises, especially given the “initial conditions” on which (and when) the policy is put to work. This just adds to worsen the overall situation, not only the real side of the economy, but could potentially be expanded to the monetary side—hopefully the increase in expenditures will not be monetized, because if it is, bye-bye…
Let me clarify that I do not necessarily mean that counter-cyclical fiscal policy is a bad thing; it depends. But in the case of Argentina, where the ‘good times’ had been wasted, it does not make much sense now. The more so since the government has been praising its policy of de-indebtedness since 2003, while the debt has actually increased. It can even be considered unfair for those (countries) that did behave “properly” and saved in good times for the bad times. But I guess the (sophisticated) market, unlike Argentina’s government, will internalize this.
To sum up, Argentina’s government put the country into an unsustainable path during the Kirchners’ administration. Now, the day of reckoning is approaching. The government, again, does not quite understand the sources of the problem and the way to address it. Furthermore, the economic crises-mode that the government put the country in can be compounded by the political crises that seems to be already in motion—which looks likely to worsen during the election year (2009).
The saddest part of this is the long terms effects. Poverty, if appropriately measured reached levels similar to the 2001-2002 collapse. Education and health did not improve in these years with all the supposed abundance. Thus, the correction that the economy will need to go through will only re-enforce this, worsening the country’s income distribution. But let’s be clear: it is not the market’s fault; it is solely the effects of the Kirchners’ administration that is forcing the market to internalize this mismanagement. Of course, we will see how this story ends as more information is made available—hopefully non-massaged data, though.
[1] “On Asymmetric Business Cycles and the Effectiveness of Counter-Cyclical Fiscal Policy,” Journal of Macroeconomics, Volume 30, Issue 3, September 2008, 885-908 and reproduced here with the author’s permission.
Tuesday, December 9, 2008
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.
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.
Friday, November 28, 2008
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.
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