Wednesday, August 10, 2011

More on FT's negative propaganda on Argentina

I had promised to return to the issue of inflation in Argentina, in my previous post about the Financial Times' biased coverage of the Argentine boom post-default and devaluation in 2001-02.  The important question, and not only in the Argentine  case, is whether inflation is somehow associated to excess demand,  which would justify the conservative calls to cool down the economy and promote tighter monetary and fiscal policies.  The graph below shows average capacity utilization in the Argentine economy, and it clearly shows that since 2006 the levels have reached the normal position close to 80% of utilization.

The same can be seen in the measure of the output-to-capital ratio presented below.  In other words, investment has allowed capacity to adjust to demand, and the level of the Y-K ratio to return to its normal level.  In other words, the boom has allowed the economy to recover normal levels of capacity utilization, and if the economy grew at a faster pace, capacity would have most likely adjusted.  The only way that the economy would reach full capacity would be if the rate of growth of demand was considerably faster than the ability of capacity to adjust.  From 2003 to 2010 GDP (proxy for demand) grew around 60%, while investment did 147% (the adjustment of capacity), on a cumulative basis.  Also, even though unemployment fell from close to 25% to around 7.5%, there is space for lower levels of unemployment, something that is particularly in an economy with significant numbers of employees underemployed, or employed in low productivity activities.

The real danger, as always for developing and peripheral countries, comes from the balance of payments.   The graph below shows the current account to export ratio.  Clearly the space to grow without reaching the external restriction has shrunk during the boom, approaching zero in 2011, but the limit has still not been reached.  This would be a limit, but not a capacity limit.

In sum, inflation cannot be associated with excess demand, since the evidence does not support that the economy is above maximum capacity.  Further, well understood what I'm suggesting is that capacity does adjust to demand, so inflation in normal times (exclude wars and other catastrophic events) is related to cost pressures. I'll deal with the evidence for commodity prices, and distributive conflict in another post.

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