The ruling coalition was stunned to lose primaries in September, which served as a warm-up for the election. Cristina Fernndez de Kirchner, the powerful vice-president who served as president from 2007 to 2015, concluded that the government had intervened in the economy too little. The ruling coalition will be able to blame price increases on greedy enterprises thanks to Mr. Feletti’s controls.
“According to Federico Sturzenegger, a former president of the central bank, “there is no economic logic, it’s purely communicational and political.” Argentina’s government is to blame for the country’s highest inflation rate of any of the world’s major economies (barring Venezuela, whose government is even more addicted to controls). After taking government in December 2019, it had already capped electricity charges and loan rates. However, its failure to strike an agreement with the IMF prevents it from accessing foreign loans. As a result, it is primarily printing money to finance this year’s fiscal deficit, which is expected to be roughly 4% of GDP. “Mr. Sturzenegger points out that “money pursues other goods,” causing inflation to rise.
Some history
Argentina competed with other South American countries and a few countries from other areas of the world for the dubious honor of having the world’s highest inflation rate from the end of WWII until the 1990s. The price rise in Argentina was propelled by rapidexpansion of the money supply, as is always the case with rapidinflation. The government needed a system of taxation that was difficult to dodge and politically simple to execute, and seigniorage collected by monetary expansion fit the bill.
Argentina, like many other chronic-inflation economies, had repeated bouts of hyperinflation followed by attempts to stabilize the situation. In such an inflationary economy, a typical cycle begins with an increase in money production to meet the government’s financial needs. As inflation rises, political pressure to lower it grows, eventually leading to “monetary reform.” The introduction of a new currency (which is convenient because inflation has typically moved nominal prices of goods and services into the thousands, millions, billions, or even trillions of units of the old currency) and promises from the government (which is in charge of the budget) and the central bank (which is in charge of issuing money and is often under direct control of the government) to follow rules leading to slower monetisation are common examples of such reforms.
These rules are frequently in the form of monetaryrules, in which the central bank promises to keep the money supply growth rate within set bounds. Alternatively, under a so-called exchange-rate regulation, countries may guarantee to keep the foreign-exchange rate (the amount of domestic currency required to purchase one dollar in the foreign-exchange market) steady.
Credibility is a fundamental issue with anti-inflationary reforms. People become increasingly dubious of government and central-bank promises to keep inflation under control after inflationary expectations have been engrained in a society. They maintain “defense mechanisms” against the consequences of inflation and the inflation tax as a result of their skepticism.
Keeping wealth in non-inflationary forms is one of these defense mechanisms. People in high-inflation countries often protect their money by holding assets denominated in US dollars. Wealthy members of these groups frequently put their money in American banks or own stock in American companies (this is called “capital flight”). Less affluent people frequently carry $100 bills. Another type of “inflation hedge” is real assets that are not directly tied to the financial sector. Many people in high-inflation economies choose to invest in tangible assets like houses, gold, or even rice rather than financial assets like bank deposits.
Contract and payment indexation is another typical defense strategy. This entails incorporating an inflation-based adjustment of all nominal payments within the contract to account for price fluctuations. Although indexation is tremendously beneficial in assisting an economy cope with excessive inflation, it can also add to inertia, making it more difficult for the central bank to control inflation. Wages (or whatever remuneration is provided for in the contract) may continue to climb after inflation has halted in some forms of indexed contracts. As a result, wage costs continue to rise, forcing businesses to raise prices even after monetary expansion, which was the primary cause of inflation, has slowed.
Argentina had gone through nearly a dozen cycles of hyperinflation and reform by 1990. None of the changes managed to keep inflation low for more than a few years before budgetary pressure and a loss of credibility prompted the central bank to abandon monetary restraint and ramp up the printing press once more. The public’s mood was a mix of desperation for inflation to be eradicated and deep scepticism about the likelihood of effective anti-inflationary actions.
In 1990, President Carlos Menem and his economics minister, Domingo Cavallo, embarked on a really extreme anti-inflationary reform: they introduced a currency board, a straitjacket monetary system. Every unit of the domestic currency (the peso in Argentina’s instance) is backed by a corresponding number of units (one in Argentina) of dollars or other foreign currencies in the central bank’s vault under a currency board (which was also routinely used to control the money supply of Hong Kong). The central bank is only allowed to expand the money supply when additional dollars arrive into its coffers (for example, when the country has a trade surplus). This eliminates the prospect of fiscal expansion of the money supply. The Argentine central bank agreed to swap dollars for pesos on a one-for-one basis, meaning that anyone who handed in a peso might get a dollar in return.
A currency board eliminates the central bank’s capacity to issue money voluntarily. Its primary flaw is that it makes it impossible for monetary policy to adapt to domestic economic conditions like recession or banking crises. The currency board, on the other hand, makes sustained inflation impossible as long as it is in place.
The following are excerpts from Domingo Cavallo’s article “Lessons from the Stabilization Process in Argentina, 1990-1996,” which was published in the proceedings of the Federal Reserve Bank of Kansas City’s 1996 symposium AchievingPrice Stability.
The stabilization plan
The government began overhauling the organization of the Argentine economy in 1990. It featured (a) total liberalization of foreign commerce and capital movements, (b) privatization of public businesses and economic deregulation, (c) reduction of the public sector’s bureaucratic apparatus and tax system reconstruction, and (d) the development of a new monetary system.
Government spending plummeted from 35.6 percent of GDP in 1989 to 29.8 percent in 1990, and then to 27 percent of GDP in 1995. The budget deficit fell rapidly from 7.6% of GDP in 1989 to 2.3 percent in 1990, and from 1991 onward, it hovered around 0%, following the economic cycle.
In competitive and open markets, prices for products and services began to be established freely. Since April 1991, all financial and commercial transactions have been conducted in the currency of the public’s choice. The convertible peso, which came with the central bank’s metamorphosis into a virtual currency board, was one of the options. The central bank must back each peso in circulation by an equal amount of gold or foreign exchange, allowing peso holders to exchange one peso for one dollar at any time.
Indexation clauses and other monetary changes in contract conditions were prohibited by the same statute that created this monetary system. Wage agreements reached through collective bargaining had to be accompanied with productivity agreements.
Inflation declined from 1,344 percent in 1990 to 84 percent in 1991, 17.5 percent in 1992, 7.4 percent in 1993, 3.9 percent in 1994, 1.6 percent in 1995, and 0 percent in 1996 during the twelve-month period between June 1995 and June 1996.
The new monetary system fostered a significant growth in the external reserves that back the central bank’s monetary liabilities. Reserves increased from $3.8 billion at the end of 1989 to $17.9 billion in 1994. This trend was reversed when a drop in confidence following the devaluation of the Mexican peso resulted in capital flight from Argentina, with reserves falling to $12.5 billion by the end of March 1995. However, confidence was restored as a result of the policies implemented in response to the crisis. Reserves have already topped $20 billion by the end of June 1996.
GDP increased at an annual rate of 7.7% on average between 1991 and 1994. However, the economy entered a period of recession after the second quarter of 1995 as a result of capital flight. The recession lasted a year, and the economy was already showing indications of recovery in the second quarter of 1996, with an annual rate of 3%.
Exports, which had been almost static for the preceding decade, rose rapidly during the stabilization period.
With the start of the recession in 1995, imports, which had increased substantially faster than exports until 1994, dropped.
Despite the substantial growth in GDP, employment developed slowly and experienced a decrease during the recession that began in 1995. The significant growth in worker productivity, which by mid-1996 had reached 1980 levels, explains the economy’s poor performance in regard to employment. The tremendous growth of the economy during this time allowed for the conversion of many low-productivity or unproductive activities that had been artificially formed during the 1980s decade into productive endeavors. This, however, was insufficient to engage the whole labor force. As a result, starting in 1992, the unemployment rate rose, reaching a high of 18.4% of the working population in May 1995. There has been a small decline in unemployment since then. In May 1996, a poll revealed a rate of 17%, which was still three times greater than in the 1980s.
The percentage of households living in poverty (an average of 26 percent in the late 1980s, rising to 29 percent during the hyperinflationary period) decreased to 13 percent in 1994, but rose to 17 percent during the 1995 recession.
Lessons of the Argentine disinflation
The fundamental takeaway from Argentina’s stabilization experience is that inflation may be eliminated even when an economy has been plagued by it for decades. Even after many years of looking for stability, it is not necessary to accept yearly inflation rates of around 10% in Latin American economies.
Another key takeaway from the Argentine experience is that fiscal adjustment, defined as a reduction in government spending, as well as the reduction and elimination of budget deficits, are the keys to stabilization after decades of instability, the source of which is primarily monetary financing of persistent fiscal deficits.
The application of basic discipline on both the private and public sectors is of particular relevance in a society in economic instability owing to inflation. External and internal competitionachieved through economic liberalization, deregulation, and the privatization of public companiesis an outstanding private-sector disciplining tool. The budget is the public sector’s disciplinary instrument. The monetary system is critical for achieving the transparency required for markets and the budget to work effectively.
In Argentina, the achievement of stabilization is attributed neither to quantitative control of the national currency nor to setting its value in terms of the dollar, because these two monetary policy norms were not strictly followed. The government gave the people the option of using any currency they wanted in their transactions and savings. In practice, the public was given the option of choosing between the American dollar, which the public had previously converted into its currency during hyperinflation, and the convertible peso, which the central bank began to offer. This currency should be at least as stable as the dollar, according to the Convertibility Law. As a result, its initial production was limited to the amount that could be backed by the central bank’s gold and foreign currency reserves. The prohibition on monetary adjustments or indexation clauses in contracts was maintained due to the freedom to choose the currency to employ, which was not necessarily restricted to the peso and the US dollar. This was crucial in eradicating all traces of inflationary inertia from the system.
The peso’s stability in relation to the dollar was not an impediment to a strong expansion of exports, which was far bigger than in the previous decade, when the Argentine currency was drastically overvalued. It was also unnecessary to depreciate the peso in order to decrease the current account deficit of the balance of payments, which peaked at 3.3 percent of GDP in 1994 before plummeting to just 0.9 percent in 1995.
The peso’s stability was critical in encouraging public officials and private enterprises to focus more on the real determinants of external competitiveness, such as economically distorting laws and taxes, as well as factor productivity.
The significant economic growth during the stabilization period can be explained by an increase in investment and productivity rates. Allowing higher inflation could not have prevented the rise in the jobless rate. With the exception of the year when the economy was in recession, aggregate demand was consistently rising and threatening to overheat the economy. The causes of unemployment can be traced back to labor market institutional rigidities and 1980s low productivity levels. In both cases, the price stability-achieved transparency offers a much more favourable climate for enhancing the quality of the public policy debate and labor talks that are required to overcome them.
Everything didn’t turn out to be rosy
The aforementioned case study was first published in 1998. Argentina’s financial system began to unravel shortly after that. In early 1995, the banking sector had a crisis as a result of unrelated problems in Mexico, which resulted in a loss of confidence in Argentina. Some of Argentina’s most important banks were in crisis, and the currency board structure prevented the central bank from taking any remedial action, such as acting as a lender of last resort or engaging in general monetary expansion.
Then, in early 2002, a combination of bank problems and mounting government debt triggered a national economic crisis comparable to the Great Depression in the United States. While the currency board was not to blame for the crisis (government budgetary recklessness was), it did limit the central bank’s ability to assist alleviate it. We won’t go into detail about the latter crises because the major focus in this case is on defeating inflation; but, if you want more information, you may read this piece from The Economist’s March 2, 2002 issue for a detailed explanation of the downturn.
Argentina has reverted to some of its previous populist measures in the aftermath of the crisis. Although inflation has not skyrocketed, it has been running at much higher rates than it was during the currency board period. A more recent comparison of the economic policies and outcomes of Argentina and Brazil may be found here.
Questions for analysis
1. What were the consequences of Argentina’s high and fluctuating inflation before to 1990 on the “real” side of the economy? What sectors of society suffered the largest losses? Were there any people who benefited?
2. Why does hyperinflation occur if everyone believes that it is bad? There is some evidence that countries with central banks that are not controlled by the elected government have lower inflation rates. Why is this the case?
3. What is the primary benefit of a currencyboard system in terms of anti-inflation credibility? Why is trustworthiness so important?
4. During the Mexican currency crisis in 1995, some international speculators withdrew funds from Argentine pesos and other South and Central American currencies, fearing that the peso would devalue against the dollar. Explain why a devaluation of the peso could not occur as long as Argentina adhered to its currency board policies.
Is Argentina’s inflation high?
But it’s been the case in Argentina for decades, where inflation hit 50% last year and is forecast to hit 50% again in 2022. The long, steady rise in prices in this South American country has prompted a variety of efforts to mitigate the effect.
How is Argentina’s inflation?
The news that inflation in the UK has risen to 5.4 percent, the highest level in over 30 years, has sent shockwaves through society, as many people struggle to keep up with growing prices.
However, annual inflation in Argentina reached 50.9 percent in 2021, up from 42 percent in 2020 and 53 percent in 2019. According to data provider Statista, the country has had one of the highest inflation rates in the world over the past five years. Because of the volatility, President Alberto Fernndez praised the fact that inflation in December 2021 was lower than a year earlier – although only decreasing 0.2 percent.
The peso’s value has plummeted in the last 20 years. It was on level with the US currency two decades ago, but now one peso is worth less than one penny. While the numbers are astonishing, everyday individuals are affected on a personal level.
What causes high inflation rates?
- Inflation is the rate at which the price of goods and services in a given economy rises.
- Inflation occurs when prices rise as manufacturing expenses, such as raw materials and wages, rise.
- Inflation can result from an increase in demand for products and services, as people are ready to pay more for them.
- Some businesses benefit from inflation if they are able to charge higher prices for their products as a result of increased demand.
Why is Argentina in such disarray?
The pandemic has intensified a flight of foreign capital, lowering the value of the Argentine peso. As a result, the cost of imports such as food and fertilizer has soared, and the inflation rate has remained above 40%. More than four out of ten Argentines live in poverty.
An inevitable renegotiation with the International Monetary Fund, which Argentines despise for imposing painful budget austerity as part of a bailout deal two decades ago, looms over national life this year.
Argentina must draw up a new repayment schedule for $45 billion in IMF obligations after the pandemic decimated its public resources. The most recent and largest bailout in the fund’s history a $57 billion package of loans provided to Argentina in 2018 is to blame for this burden.
The fund’s customary veneration for austerity has waned under new management, easing some of the normal worry. Regardless, the negotiations will undoubtedly be difficult and politically tumultuous.
Is the economy of Argentina improving?
BUENOS AIRES, Argentina Alberto Fernndez, a presidential candidate in 2019, frequently refers to Argentina’s early-2000s economic crisis. In 2003, he put himself at the center of the country’s recovery (he was cabinet leader at the time), but he made one significant edit: the crucial and fruitful 2002 the crisis’s key turning point was pushed under the rug.
Twenty years later, that tumultuous year’s legacy is more relevant than ever. But now that Fernndez is president, he appears to be repeating the same mistakes. Despite claims of an economic recovery from the epidemic and the challenges that preceded it, the government’s policy is putting the country back on a downward spiral. It’s never too late to learn from the mistakes of the past.
Around this time in 2002, a small group of government economists met on weekends in Buenos Aires to plan for the day after Argentina’s 10-year-old currency board was decommissioned. This fixed exchange rate regime, which allowed the central bank to generate money only in return for international reserves, had unintentionally triggered a crisis of rising unemployment and poverty, angry depositors, collapsing banks, and escalating exchange rate pressures. Weekends provided an artificial reprieve from the everyday crisis the sole chance to plan for anything other than the next day’s calamity.
In retrospect, the semblance of a strategy that emerged from these discussions appears more planned than it actually was. In reality, the government’s response was a jumble of desperate defensive measures aimed at containing a tsunami: a devaluation combined with export taxes, a forced conversion of domestic dollar debts at the previous one-to-one parity, exchange and capital controls, a utility rate freeze, tight monetary policy, and a heavy reliance on public transfers as a Band-Aid for rising poverty.
Some of the measures were unavoidable, some were warped by political compromise, and still others were impacted by vigorous lobbying. But, with the exception of monetary policy (which turned more expansionary in 2003 and stayed that way for a decade), the ramifications of the measures adopted in those tumultuous days of 2002 are still present in Argentina’s economy today. Firms remain underleveraged, utilities remain subsidized, banks are de-dollarized, and export taxes continue to be a major source of foreign money.
What does this imply for Argentina’s recovery post-COVID? To begin with, a detailed reexamination of the 2002 legacy casts doubt on the government’s claims of a miraculous recovery from the pandemic.
Despite a mess left over from the previous administration in 2019, the Fernndez government was able to restore growth, employment, and investment to pre-crisis levels while improving public finances, thanks to dynamic economic activity, higher and more progressive tax rates on wealth and corporate income, and a successful debt exchange in 2020.
The most recent data, on the other hand, paint a more confusing picture. With the exception of primary exports, which benefited from a huge backlog in 2021 but are expected to fall in 2022, exports are still trailing their corresponding 2019 statistics. Because producers rushed to buy capital and intermediate goods at a subsidized exchange rate, imports outperformed exports, putting currency risk and capital flight at risk. GDP has yet to return to pre-COVID levels; by the end of 2021, it would have recovered epidemic losses, as did most other nations in the region, but it would still be below its 2018 peak (Argentina’s crisis occurred two years before COVID). When expressed in terms of per capita, these results appear to be slightly worse.
Argentina’s recovery has been patchy as well. It has been concentrated in industries like construction (a dollar replacement for exchange controls) and manufacturing (cars, textiles, and electronics), which are protected from foreign competition by import barriers and a huge spread between the official and free exchange rates. While this premium reflects speculative savers migrating away from the peso, it is also supported by the peso’s deliberate appreciation to contain (or rather, postpone) inflation. This misalignment of currency rates, along with export taxes and surrender requirements (the duty to sell export dollars), is already suffocating one of the economy’s most competitive sectors: knowledge-based services.
In terms of “improving fiscal finances,” a quick look at the composition and evolution of spending in 2021 reveals that the lower primary deficit (an expected 2.5 percent of GDP, well below initial official forecasts of around 4%) was largely achieved thanks to inflation, which increased from 36% in 2020 to 51% in 2021. Pensions and social handouts are linked to historical inflation and wages, so when inflation is strong and accelerating, they fall in real terms (because past inflation is below current inflation). As a result, a decrease in social spending somewhat compensated for an increase in utility subsidies for middle- and high-income households hardly a progressive policy combination.
Regrettably, this accounting alchemy works in both directions. If inflation slows and falls, fiscal spending grows in real terms. In 2022, there’s a slim probability that this will be a factor: To meet IMF demands, the government will have to eliminate utility subsidies and foreign exchange intervention, loosening the last two inflation anchors. However, inflation will have to come down sooner or later, and in that case, fiscal dividends would have to be replaced with genuine fiscal consolidation.
On the 20th anniversary of the 2002 crisis, there has never been a more appropriate time for the administration to reflect on the country’s current situation than now.
Perhaps the most common misconception about Argentina’s swift post-crisis recovery in 2002 is that it was triggered by the devaluation, which resulted in increased exports and more dynamic import substitution. While the latter may have played an impact, export volumes expanded at a slower rate than before the currency board, and the global commodities price bubble was still in its early stages when output peaked in 2002.
Instead, the primary source of recovery was an unexpected and politically unpopular source: corporations. As it turned out, the crisis-resolution package moved public and private profits to enterprises’ internal funds, which were then reinvested domestically, by alleviating corporate indebtedness (with the peso conversion) and operational costs (with subsidized utilities and depressed real wages). This explains why investment picked up again despite the lack of a functioning financial sector. As a result, growth accelerated job recovery and poverty reduction and, along with increased taxes and a commodity boom, provided the fiscal and external surpluses that were squandered in the late-2000s fiscal spending binge.
So, contrary to what some observers believed while advocating the “Argentina solution” to the euro crisis, it was not export-driven development that got the country out of problems. It was also not a state-led Keynesian push, as some in the government may believe today. Another characteristic of the post-2002 situation that remains significant is the fact that the government is broke and, despite a “successful” debt swap, is nonetheless barred from foreign financial markets as if it were still in default.
The ideological ambiguity of an inclusive recovery largely caused by a regressive shift to the private sector makes this version of Argentina’s unintentional 2002 miracle less appealing at first glance, despite being more real and relevant to present situations. While growth may not trickle down sufficiently in normal times, when the state’s resources run out, private investment and growth may be the only way to recover.
On this front, the Fernndez government appears to be split almost self-contradictory : it calls for more exports and investment behind closed doors while continuing to squeeze the private sector to fund an illusory consumption-driven recovery, including through inexplicable (and hardly green) gas and electricity subsidies. It is also on the verge of extending its stranglehold on private operations, most notably through airline industry regulation and national airline management.
If the administration fails to learn from the mistakes of the past, it will be unable to achieve the post-2002 recovery it seeks, worsening a crisis that has already lasted far too long.
What went wrong with Argentina’s economy?
Jurez Celman’s government experienced a significant growth in the debt-to-GDP ratio near the conclusion of his term, as well as a worsening fiscal condition. The merchant bank Baring Brothers had formed a close and profitable relationship with Argentina, and when Celman’s administration failed to make payments to the House of Baring, a financial crisis occurred. Argentina defaulted, resulting in bank runs and the demise of Baring Brothers. The crisis was triggered by a lack of coordination between monetary and fiscal policies, which eventually led to the financial system’s collapse. The government’s immigration subsidies program was ended in 1891 after the financial crisis of 1890 left it with no cash. Argentina’s loans were severely restricted, and imports had to be drastically reduced. Exports were less damaged, although it took until 1898 for the value of Argentine exports to equal the peak of 1889.
After the restoration of convertibility in 1899, Celman’s successor, Carlos Pellegrini, established the groundwork for a return to stability and growth. He also reorganized the financial industry in ways that would restore medium-term stability. Rapid growth rates quickly returned: from 1903 to 1913, GDP increased at a rate of 7.7% per year, and industry grew even faster, at 9.6% per year. Argentina had cleared the remaining traces of the 1890 default by 1906, and had re-entered the international bond markets a year later.
Nonetheless, fiscal instability was a passing fad between 1853 and the 1930s. The depressions of 187377 and 189091 were critical in supporting the expansion of industry: industry grew slowly in the 1870s and more forcefully in the 1890s in response to a damaged economy’s need to redress its trade balance through import substitution. By 1914, manufacturing employed roughly 15% of the Argentine workforce, compared to 20% of the workforce engaged in commercial activities. In 1913, the country’s per capita income was comparable to that of France and Germany, and considerably ahead of that of Italy and Spain. Argentina had a gold stock of 59 million by the end of 1913, accounting for 3.7 percent of the world’s monetary gold and 1.2 percent of global economic activity.
When was Argentina the wealthiest country on the planet?
Argentina was one of the wealthiest countries in the earth at the turn of the twentieth century. It was wealthier than France or Germany in 1913, nearly twice as prosperous as Spain, and its per capita GDP was nearly as high as Canada’s.
Is Argentina currently affordable?
Argentina is very reasonable for individuals bringing in high-value currencies as of this writing (March 2021), yet it is more expensive than most other South American countries. If you’re on a strict budget, plan to pay as low as US $22-30 per day, which includes hostel lodging, affordable meals, and local public transportation.
Patagonia and certain other popular tourist destinations, such as coastal cities like Mar Del Plata and Pinamar and the famed Iguazu Falls, are more expensive. These destinations are usually popular with both residents and visitors from around the world. Traveling to isolated regions can also be more expensive, as supplies are more difficult to carry.