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.
Monday, February 2, 2009
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.
Subscribe to:
Posts (Atom)