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

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.

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

  1. Pablo   August 2, 2008 at 2:13 pm

    Hi Nicolas,this is a nice article, but there are a few points that I would like to mention.Why do you assimilate the VAT to the inflation tax? The latter is the depreciation of the liabilities of the Central Bank. Surely, the VAT benefits from higher prices, but that is also true for any tax that is defined ad valorem of nominal values (e.g., the income tax, capital gains, estate). Inflation is a bad thing, but if you have inflation, there’s nothing wrong with collecting more revenues via VAT. And the Olivera Tanzi effect affects VAT less than what it affects income taxes, since the time elapsed between imposition and effective collection is shorter.Why do you say that this is a consumption-driven economy? Exports and investment have been growing consistently faster than the GDP and, the last time I checked, investment was at record high levels as a fraction of GDP. Consumption has been growing too, but is far from being the most dynamic component of aggregate demand.You say "every profit looks like "extraordinary profits"". You are simply quoting one of the arguments of the opponents to the export taxes. Granted, the existence of "extraordinary profits" in the agricultural sector (and only there) was one of the arguments the govt used to push for the export taxes. But that isn’t totally at odds with the economic theory of "pure profits" in industries where one factor of production is fixed (as is the case with agricultural production). On the other hand, a lot of other industries have benefited from the recent growth, and the government didn’t try to collect additional taxes on those profits."Families are highly indebted". Is that so? I never saw statistics in that regard."The real exchange rate has been continuously appreciating". Shouldn’t that precisely counteract inflation?I don’t mean to say that there are no problems. But I find it hard to see from your recount how this could end in a hyperinflation, even without drastic corrective measures. I agree with the need to curtail subsidies, but that can be done gradually, as apparently the government is intended to do it. I might be overoptimistic, but don’t forget that in April 2002 almost all economists cried "Hyperinflation!!" and here we are, six years after, still waiting with no sight of the wolf.Best

  2. Nicolas Magud   August 2, 2008 at 11:47 pm

    Dear Pablo,Thanks for you comments. Let me address them, clarifying what I think that you might have not understand from my posting.1. Of course that what applies to VAT also applies to any other element that is indexed by inflation. As the post states this is just an example—of the many—on how the revenue is mainly driven by inflation. That is precisely the point, however, in that tax revenue is clearly not such an achievement as the government likes to claim once you take into account that those revenues are mainly explained by inflation (and exports, of course; more below). Regarding the Olivera-Tanzi effect, the revenue—regardless of the source—should not come out of high inflation. It is a fact that there is higher global inflation, but Argentina clearly (and negatively) separated from it. Eventually the long-term costs of it will be seen.Consumption-driven economy. What were the engines of growth during these administrations? (i) Government expenditures. (ii) Exports, in part but not because of the government but despite the mistakes of the government—mainly due to the global boom. It would be non-sense to think that exports would have grown that much without the external commodities’ boom. (iii) Investment: cell-phones? Long-term investment? More importantly, the point here is what explains GDP growth in this period; it not the level per se, but how much it contributes to explain growth. Note also that if you could disaggregate long-term vs. short-term investment, the share of the latter would tend to be higher and with higher expected margins since the weak property rights require investments to be recovered rapidly—the medium run is too far away in time! Any of my undergrad students knows this.Extraordinary profits. Let me be clear that I don’t support either the government or the opposition in this piece—I just want everybody in Argentina to be better off. That said, a necessary condition for sustained long-term growth is, one more time, respect for property rights. The economics of incentives implies that if you want firms to take risk and invest (potentially losing or winning) you need to respect property rights. Looking at the world-wide experience, big economic successes usually need property rights to be respected. The empirical evidence on the role of institutions and property rights is not tiny and it is strong.Indebted families: Central Bank reports and private sector reports.Real exchange rate. I guess that you might be a little bit confused here. If you keep the exchange rate highly managed and semi-fixed, as far as the rate of inflation is greater than the rate of change of the depreciation of the nominal exchange rate, then the real exchange rate appreciates. On the contrary, I guess that you might get mixed up with appreciating the nominal exchange rate to try to reduce the growth rate of prices. This has been many times part of an anti-inflationary program, but it is not one on its own. For evidence, I would suggest that you review the Argentine history of the 1970s and the early 1980s. In any case, it is not the same if the real appreciation comes from a flexible exchange rate that accommodates changes in relative prices, holding prices with minimum change than if it comes from inflation. However, if you don’t let the exchange rate adjust, the relative price adjustment will come from domestic prices. Probably the classical contributions on Friedman will help clarify this.Hyperinflation. If you read the posting carefully you will see that I am not claiming that hyperinflation will necessarily come back. I claim that should the government not apply the corrective measures soon things might get nasty (I would love to see subsidies reduce, although I doubt that will happen…), the more so if you factor in the fact that wrong investment incentives might have a negative effect on the external balance. If that happens, I would be very worried. Regarding 2002, I think that should this so-called “Productive Model” not been implemented, the economy and the income distribution, and any welfare measure that you would like to look at would have looked better now, and more importantly, with a brighter future. May be I am too pessimistic. I really hope the latter is true and that everyone in Argentina is better off for the foreseeable future.

  3. Pablo   August 4, 2008 at 11:01 pm

    Dear Nicolas, thanks for your thoughtful response.My first point was more technical: "inflation tax" has a very specific meaning, different from than the one you gave. On the other hand, it is at least curious how much emphasis you put on the inflationary nature of the growth in govt revenues, and yet you don’t apply the same criteria for govt expenditures. To be consistent, you should treat both revenues and expenditures either in real or nominal terms. Instead, you discount revenues for inflation but say that expenditures growth is "in the 40% area"."Indebted families": I meant to ask what are the numbers. I guess most of your readers don’t have access to these data, so it would nice if you illustrate the point. Are current levels that bad compared to historical figures?Real exchange rate: appreciation as an anti-inflationary tool when the origin of inflation is domestic (as was the case in Argentina 1970/80) is different from today, when the origin of inflation is a (deliberately) depreciated peso. Nominal appreciation might be "cleaner" than real appreciation through inflation, but the final outcome is the same.Hyperinflation: well, the very asking of the question by you says a lot to me. I don’t think there’s the slightest chance of that happening but, who knows."I just want everybody in Argentina to be better off". We are on the same boat there.

  4. chegewara   August 8, 2008 at 11:09 am

    argentina has amongst the lowest private debt ratios in the world. if i recall correctly, mortgage debt to gdp was about 5% or so.the biggest problem in argentina is the amount of CER linked debt, making it impossible to inflate out of the problem. so the country decided to assume inflation away, driving yields up and now the only way they can issue in the market is to chavez. the game ends when oil prices fall and chavez has no $ to buy argy bonds no more.the best outcome of that would be a deposition of kirchner regime. other than that, argentina is sounder than most of the EMs out there, with CA and public surpluses.