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

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

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

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

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

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

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

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

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

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

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

Argentina and the contractionary effects of expansionary fiscal policy

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

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

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

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

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

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

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

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

Is Argentina running out of funds?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

---

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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