Wednesday, October 3, 2018

Latin America Monetary and Fiscal History: One Country at a Time

Those interested in the economies of Latin America will want to take a look at "The Monetary and Fiscal History of Latin America," a collection of papers published in August 2018 by the Becker Friedman Institute at the University of Chicago.  It's a set of 11 papers, one on each of the 11 largest Latin American countries from 1960 up through 2016--that is, the papers get up to recent times, but don't try to do current events. A full list of the papers is at the bottom of the post, with abstracts and links.

The papers focus is on monetary and fiscal policy, and mostly don't seek to provide an even broader overview of economic evolution in these countries. But the nonspecialist reader interested in general patterns and trends in these countries will still find much of interest. For example, here's a snippet from Diego Restuccia on "The Case of Venezuela":
"In the post-war era, Venezuela represents one of the most dramatic growth experiences in the world. Measured as real gross domestic product (GDP) per capita in international dollars, Venezuela attained levels of more than 80% of that of the US by the end of 1960. It has also experienced one of the most dramatic declines, with levels of relative real GDP per capita reaching less than 30% of that of the US nowadays.  ...

"The last period, from 2006 to 2016 deserves special discussion. This is because the crisis that is unfolding is much more closely aligned with the typical crises in Latin America ... that is, the link between systematic government deficits, the eventual inability to finance those deficits, and subsequent seigniorage and inflation. This is also a period in which distortions to economic activity have accumulated since the late 1990s and were drastically expanded during this period of time.
"There are several aspects of the economic environment that are worth mentioning. First, there is extreme intervention of the public sector in economic activity through expropriation of private enterprises and government intervention of goods distribution systems. Decline in private production and the failure of expropriated enterprises have exacerbated the dependence of the economy on imports. Second, this is a period of rising debt, both internal and external, with the internal debt becoming the majority of new debt as external sources of financing have become more limited toward the end of the period. Third, there is a decline in the transparency of debt statistics, as a substantial portion of new debt is not accounted in official statistics, for instance, loans in exchange of future oil (e.g., China) and newly rising debt of the state-owned oil company (PDVSA). Fourth, there was a partial reform of the Central Bank allowing for the discretionary use of foreign reserves. Fifth, there is a changing role of PDVSA’s activities involving large transfers ... for social programs; in addition, government intervention in the company’s activities has meant shrinking production capacity and cash flows. As a consequence of these characteristics, and despite one of the largest oil-price booms in recent history, the government has found it harder to obtain new loans with mounting fiscal deficits, resorting to much more substantial seigniorage. This is a period also in which real GDP per capita and labor productivity are contracting, for example, real GDP per capita is essentially the same in 2013 as in 2007, and declined between 2013 to 2016 by 30%."

Here's the list of papers, with abstracts and links:


The Case of Argentina
Francisco Buera, Sam B. Cook Professor of Economics, Department of Economics, Washington University
Juan Pablo Nicolini, Senior Research Economist, Federal Reserve Bank of Minneapolis

In this paper, we review the monetary and fiscal history of Argentina for the period 1960–2017, a time during which Argentina suffered several balance of payments crises, three hyperinflations, two defaults on government debt, and three banking crises. All told, between 1979 and 1991, after several monetary reforms, thirteen zeros had been removed from its currency. We argue that all these events are the symptom of a recurrent problem: Argentina’s unsuccessful attempts to tame the fiscal deficit. An implication of our analysis is that the future economic evolution of Argentina depends greatly on its ability to develop institutions that guarantee that the government does not spend more than its genuine tax revenues over reasonable periods of time.

The Case of Bolivia
Timothy J. Kehoe, Advisor, Federal Reserve Bank of Minneapolis
Carlos Gustavo Machicado, Senior Researcher, Institute for Advanced Development Studies, Bolivia
José Peres Cajías, Professor, Economic History Department, University of Barcelona

After the economic reforms that followed the National Revolution of the 1950s, Bolivia seemed positioned for sustained growth. Indeed, it achieved unprecedented growth during 1960–1977. Mistakes in economic policies, especially the rapid accumulation of debt and a fixed exchange rate policy during the 1970s, led to a debt crisis that began in 1977. From 1977 to 1986, Bolivia lost almost all the gains in GDP per capita that it had achieved since 1960. In 1986, Bolivia started to grow again, interrupted only by the financial crisis of 1998–2002, which was the result of a drop in the availability of external financing. Bolivia has grown since 2002, but government policies since 2006 are reminiscent of the policies of the 1970s that led to the debt crisis, in particular, the accumulation of external debt and the drop in international reserves due to a fixed exchange rate.

The Case of Brazil
Márcio Garcia, Associate Professor, PUC-Rio, CNPq and FAPERJ; Coordinator, Brazil Project
João Ayres, Research Economist, Inter-American Development Bank
Diogo Guillén, Global Head Economist, Itaú Asset Management
Patrick Kehoe, Consultant, Federal Reserve Bank of Minneapolis; Frenzel Professor of International Economics, University of Minnesota

Brazil had a long period of high inflation. It peaked around 100% per year in 1964, and accelerated again in the 1970s, reaching levels above 100% on average between 1980 and 1994. This last period coincided with severe balance of payments problems and economic stagnation that followed the external debt crisis in the early 1980s. We show that the high-inflation period (1960-1994) was characterized by a combination of deficits, passive monetary policy, and constraints to debt financing. The transition to the low-inflation period (1995-2016) was characterized by improvements in all those instances, but it did not lead to significant improvements in economic growth. In addition, we document a strong correlation between inflation rates and seigniorage revenues, but observing that the underlying inflation rates are too high for the modest levels of seigniorage revenues. Finally, we discuss the role of monetary passiveness and indexation in accounting for the unique features of the inflation dynamics in Brazil in comparison to the other Latin American countries.

The Case of Chile
Rodrigo Caputo, Senior Economist, Central Bank of Chile
Diego Saravia, Manager of Economic Research, Research Department of the Central Bank of Chile;

Chile has experienced deep structural changes in the last fifty years. In the 1970s a massive increase in government spending, not financed by an increase in taxes or debt, induced high and unpredictable inflation. Price stability was achieved in the early 1980s, after a fixed exchange rate regime was adopted. This regime, however, generated a sharp real exchange rate appreciation that exacerbated the external imbalances of the economy. The regime was abandoned and nominal devaluations took place. This generated the collapse of the financial system that had to be rescued by the government. There was no debt default, but in order to service the public debt, the fiscal authority had to generate surpluses. Since 1990, this was a systematic policy followed by almost all administrations and helped achieve two different, but related, goals. It contributed to reducing the fiscal debt and enabled the Central Bank to pursue an independent monetary policy aimed at reducing inflation.

The Case of Colombia
David Perez-Reyna, Assistant Professor, Department of Economics of Universidad de los Andes, Colombia
Daniel Osorio-Rodríguez, Junior Researcher, Monetary and International Investment Division, Banco de la Republica (the Central Bank of Colombia)

In this paper we characterize the joint history of monetary and fiscal policies in Colombia since 1960. We divide our analysis into three periods, which are differentiated by the finance structure of the fiscal deficit, the institutional framework of monetary and fiscal policies, and the levels of inflation: 1960-1970, when both inflation and the fiscal deficit were low on average; 1971-1990, when both inflation and the fiscal deficit increased; and 1991-2017, when despite the highest average fiscal deficit and the worst recession of the century, inflation kept a downward trend in the context of a newly independent Central Bank and increasingly flexible exchange markets. The first two periods were characterized by fiscal dominance, with larger fiscal deficits leading to increased inflation in the context of a nonindependent monetary policy. After 1991, the Constitution enshrined monetary dominance via an independent Central Bank. We observe that although large fiscal deficits, macroeconomic swings and monetary imbalances were rare in Colombia, average economic growth was comparable to other Latin American countries that experienced higher macroeconomic volatility.

The Case of Ecuador
Simón Cueva, Regional Academic Director, Laureate Latin America
Julían P. Díaz, Assistant Professor, Quinlan School of Business, Loyola University Chicago

We document the main patterns in Ecuador’s fiscal and monetary policy during the 1950-2015 period, and conduct a government’s budget constraint accounting exercise to quantify the sources of deficit financing. We find that, prior to the oil boom of the 1970s, the size of the government and its financing needs were small, and the economy exhibited high growth rates and low inflation. The oil boom led to a massive increase in government spending. The oil prices crash of the early 1980s was not accompanied by any substantial fiscal correction, and the government considerably relied on seigniorage as a source of revenue. This coincided with almost three decades of high inflation rates and stagnant output. The dollarization regime, implemented in 2000, removed the ability of the government to resort to seigniorage to cover its imbalances. Indeed, in spite of large deficits registered since 2007, inflation has remained at historically low levels. However, the recent policies of inflated spending and the heavy borrowing needed to finance it remind those that led to the collapse of the economy during the 1980s and 1990s, and generate concerns regarding the long-term sustainability of the dollarization regime, and of the benefits it has provided.


The Case of Mexico
Felipe Meza, Researcher, Centro de Analisis e Investigacion Economica (CAIE); Professor of Economics, Instituto Tecnologico Autonomo de Mexico (ITAM)

The objective of this paper is to analyze the monetary and fiscal history of Mexico using a model of the consolidated budget constraint of the Mexican government as the framework. I assume a small open economy in which the government exports oil. I study the period 1960-2016. I evaluate the ability of the model to explain the crises of 1982 and 1994, and while the model can explain the 1982 debt crisis, it cannot explain the 1994 crisis. A constitutional change in the relationship between the federal government and Banco de México, and policy choices made in the aftermath of the 1994 crisis, are consistent with a transition from fiscal dominance to an independent Central Bank. Inflation fell persistently after 1995, reaching values of 3% per year in mid-2016. That number is the target of the Central Bank. After a long transition following the 1982 crisis, Mexico succeeded in controlling inflation. I discuss forces that reduced inflation over time: a long sequence of primary surpluses, the constitutional change that gave independence and a goal to the Central Bank, and the current inflation targeting regime. On the fiscal side, I observe a change in the downward trend of the total debt-to-GDP ratio, as it fell from the 1980s to 2009, the year in which it started growing persistently until 2016.

The Case of Paraguay
Javier Charotti, Researcher, Central Bank of Paraguay
Carlos Fernández Valdovinos, President, Central Bank of Paraguay
Felipe Gonzalez Soley, Researcher, Central Bank of Paraguay

In this paper we analyze the monetary and fiscal history of Paraguay between 1960 and 2016. The analysis is divided into four periods: Golden years and large external shocks (1962-1980), Fiscal imbalances and nominal instability (1981-1990), Deregulation and financial crisis (1991-2003), and finally, the Period of structural reforms (2004-2016). We observe that the monetary and fiscal policy maintained a conservative stance relative to other Latin American countries with some episodes of fiscal or monetary imbalances. These were a consequence of different factors depending on the period of analysis, among which we can quote: reform of the legal framework of the Central Bank, stabilization plans, credit market, and structural reforms. Finally, compared to most countries in Latin America, Paraguay has not experienced large macroeconomic imbalances, but remains among the countries with the lowest income per capita levels.

The Case of Peru
Cesar Martinelli, Professor of Economics, George Mason University
Marco Vega, Deputy Manager of Economic Research, Economic Studies Depart., Central Reserve Bank of Peru; Professor, Pontificia Universidad Católica del Perú

We show that Peru’s chronic inflation through the 1970s and 1980s was a result of the need for inflationary taxation in a regime of fiscal dominance of monetary policy. Hyperinflation occurred when further debt accumulation became unavailable, and a populist administration engaged in a counterproductive policy of price controls and loose credit. We interpret the fiscal difficulties preceding the stabilization as a process of social learning to live within the realities of fiscal budget balance. The credibility of policy regime change in the 1990s may be linked ultimately to the change in public opinion, which gave proper incentives to politicians, after the traumatic consequences of the hyper stagflation of 1987- 1990.

The Case of Uruguay
Gabriel Oddone, Economic Historian, Universidad de la Republica, Uruguay
Joaquín Marandino, Researcher, Universidad Torcuato Di Tella, Argentina

This paper analyzes the monetary and fiscal history of Uruguay between 1960 and 2017. The aim is to explore the links between unfavorable fiscal and monetary policies, nominal instability, and macroeconomic performance. The 1960s is characterized by high inflation and sustained large deficits, and a large banking crisis in 1965. Since the mid-1970s, the government liberalized the economy and attempted to stop the money financing of deficits that prevailed in the previous decade. During the transition to a more open economy, Uruguay encountered two major crises in 1982 and 2002: the former was very costly in fiscal terms and brought back the monetization of deficits, while the latter had significantly lower effects on deficit and inflation. The evidence collected suggests governments have slowly understood the importance of fiscal constraints to guarantee nominal stability.

The Case of Venezuela
Diego Restuccia, Professor of Economics, University of Toronto; Research Associate, National Bureau of Economic Research (NBER)

I document the salient features of monetary and fiscal outcomes for the Venezuelan economy during the 1960 to 2016 period. Using the consolidated government budget accounting framework of Chapter 2, I assess the importance of fiscal balance, seigniorage, and growth in accounting for the evolution of debt ratios. I find that extraordinary transfers, mostly associated with unprofitable public enterprises, and not central government primary deficits, account for the increase in financing needs in recent decades. Seigniorage has been a consistent source of financing of deficits and transfers—especially in the last decade—with increases in debt ratios being important in some periods.