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.
Thursday, October 23, 2008
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?
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.
Monday, October 20, 2008
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).
Wednesday, September 10, 2008
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.
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.
[1] See Izquierdo, Talvi .and Ottonello (2008) for details.
Friday, August 1, 2008
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.
Monday, July 21, 2008
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.
Wednesday, June 25, 2008
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
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?
[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
Wednesday, May 28, 2008
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.
Friday, May 9, 2008
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 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.
Thursday, May 8, 2008
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.
[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.
Monday, April 7, 2008
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…
Saturday, March 22, 2008
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
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.
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.
[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.
Subscribe to:
Posts (Atom)