MMT, Argentina, and Views on Inflation

L. Randall Wray | October 9, 2012

On the surface, the data from Argentina look awfully good—among the top performers in the world over the past decade. And she’s apparently done it without a run-up of either private sector or government sector debt. In other words, Argentineans have bucked the trend among developed countries, that saw (mostly) tepid growth fueled almost entirely by debt.

And that seems to be at least in part due to a policy choice. Argentina had been the poster child for Neoliberal policies all through the 1990s—they adopted virtually the whole Neolib agenda lock-stock-and-barrel. They even adopted a currency board. And unlike Euroland (which also adopted something like a currency board as each member adopted a foreign currency—the euro), Argentina would have consistently met the tight Maastricht criteria on budget deficits and debts over that period. The main purpose of the austere budgets and currency board constraints was to kill high inflation. It worked. But, over that period unemployment grew and GDP growth was moderate. I won’t go further into the problems encountered at the turn of the new decade but the whole thing collapsed into a severe economic, financial, and political crisis. In a last desperation move, the government abandoned the currency board (or, you could say the currency board abandoned the government!), defaulted on its debt, and created a Jobs Guarantee program called Jefes.

(You can read more here and here; or if you want a first-hand account by Daniel Kostzer who played a major role in bringing Argentina out of crisis by helping to create and implement the Jefes program, read this.)

Starting from the depths of a horrible recession, then, Argentina climbed back to recovery—not only making up for ground lost in the downturn, but also in many ways by rectifying problems created by the Neoliberal experiment. Some of the policies of privatization have been reversed; unemployment and poverty were reduced; the trend toward rising inequality was reversed; government ran budget surpluses and the economy ran current account surpluses; investment grew at a fair clip; and so on. I’m not going to burden you with lots of data but here are a few snippets. Caveat: I realize it does depend on the starting point. If you begin at the bottom of a trough then by definition the data are going to look mighty good climbing toward a peak. But my point is that if we begin with the implementation of the policy of the Kirchners (the husband and wife tag team model to which the Clintons might have aspired) and run it to the present we get an admittedly superficial measure of success of their policy. We will turn in a minute to the argument of the critics—which is by no means a small fringe. The current President’s popularity has fallen substantially in recent months. It is that phenomenon under examination: why all the angst if the data look good?

Argentina’s per capita GDP measured at US dollar purchasing power parity is nearly $18,000 according to the IMF (note the source)—highest in South America—compared with, say, less than $12,000 in Brazil. Its Human development index is just a hair lower than Chile’s—at the top of the region, according to the UNDP. Its real GDP growth was 8.9% in 2011 and 9.2% in 2010. Industrial production has grown at an 8.1% rate since 2003. Grain production is up by a third since the crisis. Investment has risen as a percent of GDP from less than 19% in the neoliberal period to nearly 21% under the “socialist” Kirchners. And despite what you might think, the vast majority of the increase of investment has been private—not public, which accounts for only a couple of a percent. Labor’s share of GDP has been climbing toward 50%, up from 40% under the Neolibs. Unemployment rose through the Neolib experiment from a low of about 6% in the early 1990’s to around 15% before the crisis. Under the Kirchners it fell from nearly a quarter of the labor force to 7.2% today. And get this, the Gini index rose under the Neoliberals from around 0.45 to 0.50, and then to 0.53 in the crisis, but has fallen steadily under the Kirchners back to less than 0.44. (As a reminder, a Gini of 1.0 means complete inequality; a 0 means complete equality.)

What about deficits and debts? The current account was consistently in deficit under the Neoliberals—running around $10 billion annually. After the crisis it was in surplus, reaching as high as $10 billion before the Global meltdown; by 2011 it had fallen to zero. The current account surpluses allowed the country to accumulate significant international reserves—reaching over $50 billion by 2010 (falling thereafter—a point to be briefly discussed later). Government has been running large primary fiscal surpluses—on the order of 3% of GDP. This allowed it to greatly reduce government debt ratios: from 167% of GDP at the beginning of the 1990s to 42% at the end of 2011. Public debt denominated in foreign currencies fell from 133% to 25% of GDP over the same period (due in part, as mentioned above, to default). Only about half of the government debt is now held in the private sector. Corporate indebtedness is equal to 23% of GDP (this is at the very low end of the range of countries; for comparison the number is 90% in the US and 94% in Chile). Household indebtedness is an extremely low 8.4% of GDP (versus 39% in Chile and 87% in the US). That is not too surprising: with a current account surplus larger than the budget surplus the private sector has been running a surplus that allowed it to pay off debt and accumulate savings.

OK we could go on and on and on. Where’s the beef? What the heck is wrong with Argentina?

On the basis of what I saw on my latest visit, I’d finger two issues that upset a large cross-section: inflation and capital controls (to be more specific, restrictions on domestic conversions from peso to dollar holdings). Let me briefly turn to those issues.

Obviously, Argentina has a complex history that is almost unfathomable to the outsider. Among the highest living standards in the world in 1900; destination for Nazis with the fall of Hitler; land of coups and juntas and the disappeared; and Evita. I’ve visited Argentina several times and spent a fair amount of time talking to government officials, Jefes participants and project managers, and piqueteros. With good reason, there’s a fair amount of distrust—and a lot of that is aimed at government, although some government officials mistrust their constituents. So, it is not too surprising that many Argentineans buy the argument that government is manipulating data, especially on inflation.

As already discussed, the official numbers are around 10% but unofficial measures put it as high as 25%. People that I think are reasonably credible argue that the official number is too low, but the actual number is probably substantially below 25%.

Why do I doubt the higher number? When I visited Argentina early in the recovery, my own very informal survey found a purchasing power parity (that is to say, going across the exchange rates of dollars to pesos) adjusted price level of about 60% of USA prices (ironically that was about the same as Australian prices adjusted by the exchange rate—now Australia is a very expensive place for Americans to visit thanks to currency appreciation and inflation). I don’t eat burgers, so I cannot do the “Big Mac index” (I saw billboards for Mac burgers at about $3 US, but do not know the American price). Fortunately, I do have the teenage girl index. I brought my daughter along and she bought two dress shirts and a skirt at a trendy store in the Recoleta area for a US dollar price of less than a hundred bucks; that was about midway between Target prices and trendy store prices in the US—certainly nowhere near to Manhattan Boutique prices. So, Argentina prices in terms of US dollars have risen noticeably but not outrageously. Over the same period, the exchange rate of the peso has fallen, from 35 cents per peso in 2003 to 26 cents in 2009 to 24 cents last year and to 21 cents now. That, of course, helps to keep the dollar price of purchases in Argentina down—or inflation in pesos higher. But that doesn’t compute to anything like a 25% inflation rate year after year.

Yes, that is anecdotal, and tourist purchases are a small part of the consumer basket. Still, put it this way. If the inflation rate were 25% for 4 years in a row, prices would rise from 100 to 244. (The claim is that inflation has been running at 25% since 2008.) At that pace, you’d see a big difference.

More importantly, if prices are rising at a 25% pace that means real GDP is vastly overstated. Indeed, it must have been falling at a very rapid clip. That is extremely hard to reconcile with the data I reported above. Sure, you can claim government manufactured fake data on all sorts of other measures. That is why I pointed out that at least some of the data come from independent sources. If we are to believe the 25% number, then it isn’t possible for Argentina to have recovered in real terms—unemployment ought to have remained in the high double digits, the wage share shouldn’t have risen so much, the Gini shouldn’t show falling inequality (low inflation can be associated with rising equality but high inflation usually hits wages), and so on.

It stretches credulity to believe that Argentina has actually been in a deep depression for the past 4 years once we subtract the “true” inflation rate of 25% from nominal GDP to get real growth. With real GDP growth reported at 8-9%, if we subtract the extra inflation claimed to be equal to 15%, we’ve got real output falling at 6 or 7% a year—Great Depression type numbers. How on earth did Cristina Fernandez de Kirchner win the last election by a wide margin in the middle of a Great Depression? And, finally, if inflation is running at 25% and the bank overdraft rate has been running around 20% (with a spike to 25% a few months ago), you’ve got basically “free money” to play with—borrow now and pay back with cheaper pesos later—so why don’t we see in the data a big boom in borrowing and lending? (We actually see credit growth falling since last year.)

So there are inconsistencies in the data that at least cast some doubt on the claim that inflation is 25%.

Philip Pilkington has already written a very good piece on attitudes toward inflation and on the main source of the claim that inflation is actually running at 25%. See here. I won’t repeat his argument in detail, but the alternative inflation measure was created by Alberto Cavallo, an Argentinean, and Roberto Rigobon, a Venezuelan. As it happens, Cavallo is the son of the former finance minister who oversaw the implementation of the Neoliberal policies in the 1990s. Sons do not always follow their fathers in politics and ideology, but I’d be pretty darned surprised if Cavallo, Jr., is a big Kirchner supporter. (And my guess is that Rigobon didn’t cast his vote for Chavez in the recent lopsided election.) He’s probably got a dog in the hunt.

Me, I don’t. If inflation really is running at 25%, so be it. Does that make Argentina’s central bank the worst in the world? I don’t think so.

I realize that people hate inflation. Economic studies actually find that the negative economic effects of moderate inflation are small—and by moderate I mean in the range of 10% to 20%; one famous study by orthodox economists even found only small effects up to an inflation rate of 40%. Indeed, the evidence is pretty strong that employment and growth do slightly better with moderate inflation than with extremely low inflation (although stagflation is also a possible result). How much people hate inflation probably depends to some degree on how they got to high inflation, and how long it’s been going on. If inflation were to suddenly rise to 10% in the US, I suppose American voters would quickly turn against President Obama in the same way they’ve turned against President Kirchner. Latin American countries have lots of experience with what we northerners would consider to be unacceptably high inflation. Argentineans enjoyed relatively low inflation in the 1990s—as I’ve explained—and it is not surprising that they do not want to return to the pre-currency board high rates. So, by pointing out that economists do not find big negative economic effects of inflation does not mean I’m downplaying it. After all, our center at UMKC has always been called CFEPS: Center for Full Employment and Price Stability. We understand that no matter what economists say, people prefer low inflation. So do we.

It is relatively easy to formulate a policy to bring down inflation (although implementing the policy will be more difficult). Despite what you hear all the time, wage and price controls work. (J.K. Galbraith successfully fought inflation in the US with a combination of such controls plus rationing during WWII when the economy operated well beyond full capacity. Nixon also successfully used them later.) The problem is that the controls do affect incentives and generate imbalances that set up longer term problems for the economy. So it is not so much a question of whether they work, but of how you will get off them. They must therefore be implemented with a clear plan for restructuring the economy in a manner that sustained growth with price stability can be maintained after they are dropped. Ditto the currency board: it can be used to eliminate inflation, but it so constrains fiscal policy that productive capacity and jobs generating capacity are hindered. Again, you must have a restructuring and a plan to get off the currency board and back on to a sovereign currency. Finally—and this can be painful—if you’ve had inflation for a long time, your economy has probably put in place institutional measures that in a sense institutionalize inflation. Such as price indexing of wages, pensions, and interest rates. To bring inflation down, and keep it down, you will need institutional changes to eliminate the “inertia”. This is difficult, especially in a society with class conflicts—you need a buy-in of workers, pensioners, and price-setting firms to get agreement to phase-out the indexing on the expectation that inflation really will be brought down.

I’m no expert on these matters. I am favorably impressed by the work done by my friend Luiz Carlos Bresser-Pereira, former finance minister of Brazil. He played a role in bringing down inflation in Brazil and learned from the experience—including from his own admitted mistakes. What he now promotes is a new approach that he calls New Developmentalism (go here This is all well outside my area of study, but it makes sense to me. It is a new take on Latin American structuralism, with a dose of “go-it-alone” nationalism that rejects the austerity that the IMF and World Bank want to impose on developing nations. It sounds rather like the recommendations I heard the Governor of the Central Bank of Argentina as well as the Vice President making at the conference I attended. What is important is that Bresser is arguing for structural adjustment to fight inflation—not austerity. That is in-line with what I argued above. Austerity actually makes it more difficult to implement the structural changes required to permanently reduce inflation. And it worsens class conflicts since austerity hits workers and especially lower income workers more severely.

I wanted to say more about attitudes toward inflation, the supposed culpability of the Central Bank in stoking the fires of inflation, the recent capital constraints aimed at reducing dollar hoarding, and the role the mainstream media plays in promoting a growing reaction against the Argentinean Central Bank and the President, but this blog has already gone on too long. I guess there will have to be a Part 2.

Here’s the preview: no matter what the level of inflation in Argentina (10% or 25%), the central bank is not a significant contributor. Indeed, the types of policies proposed by its Governor are consistent with the restructuring that will help to reduce inflation pressures over the long run. Further, what most critics look to—the size of the central bank’s balance sheet, for example—has nothing to do with the inflation pressures. Central banks don’t do helicopter drops of money. Whenever I go outside, I look up to see if Uncle Ben Bernanke is piloting a helicopter in my neighborhood, as I really would like to get my hands on one of those infamous bags of dollars he supposedly injects into the economy. Unfortunately, I never see him. Mercedes Marco del Pont doesn’t have a helicopter, either. I looked. You’ve got to look elsewhere for the pesos—they are not falling from the sky.

(cross-posted at EconoMonitor)


One Response to “MMT, Argentina, and Views on Inflation”

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  1. Comment by Matías VernengoOctober 10, 2012 at 10:16 am   Reply

    It is also important to note that several of the economists that complain about inflation ask for a big devaluation (e.g. Pratt Gay, an ex-president of the central bank). However, if they were concerned with inflation devaluation of more than 100% as some have demanded would be significantly inflationary, with a pass-through of about 0.2 to 0.4 (that is, 20% to 40% additional inflation), with very limited impact on growth, since exchange rate export elasticities are small. Also, the demand for fiscal adjustment to control inflation is peculiar, since inflation is not demand driven. In 2009 output fell more than 10% from the previous year, as a result of the global crisis, and inflation was still at around 15% according to critics. And inflation will remain high this year even in the face of a slowdown.

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