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

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

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

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

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

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

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

n letting the currency float

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Es el Momento de un Fuerte Ajuste Fiscal

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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