Sunday, February 2, 2014

Was the devaluation in Argentina good and inevitable: A reply to Rapetti

Back in the mid-1990s I was a student of John Eatwell (his last TA in the microeconomics course at the New School, I think, before he went back to Cambridge), and one thing that has stuck with me over the years is that he argued no economic debate was ever solved by empirical evidence. Hyperbole aside, and I should say it is not a great exaggeration, logic has also not been particularly good a clarifying debates in economics (just think of the Capital Debates).

So last week I wrote this post on why the Argentine devaluation is not a traditional Balance of Payments crisis. As I noted it was a policy decision in the works for a long while. At any rate, neither the real exchange rate, nor the current account are in a position that per se is unsustainable. That is still true, however, Martín Rapetti from the Centro de Estudios de Estado y Sociedad claims I am confused in my criticism of his work, as much as that of Frenkel and Bresser-Pereira, the so-called New Developmentalists, which believe that devaluation is good for growth.

He suggests now that he does not claim that devaluation is good for long run growth (my quote from Bresser in the previous post was very clear suggesting that is in fact what New Developmentalists think). In his words:
"Formulations like mine seem to be the source of another confusion in Matias’ analysis. He argues that people like Luiz Carlos Bresser Pereira, Roberto Frenkel and me were advocating for a devaluation because we support the idea that maintaining a competitive real exchange rate (CRER) is good for growth."
He argues now that the reason for wanting a devaluation was:
"based on the inconsistencies of macroeconomic policy and not on my frustration about the abandonment of the competitive RER strategy that Argentina carried out between 2002 and circa 2008."
Althought Martín does not quite spell out what the contradictions are (and they are not the current account or the real exchange rate apparently, since he says: "He [that would be me, Matías] is right: the current account deficit was only 0.5% of GDP in 2013 (although it would higher without the import controls) and the RER is certainly not as overvalued as in Brazil (which, by the way, is very overvalued [that has no run on the currency, I might add])." The imbalances are one might assume inflation, and the cause of inflation as Frenkel and others have suggested is the excess demand (read fiscal deficits). So he wanted, and by the way I've heard this from almost anybody connected to CEDES, more fiscal adjustment. In fact, in the CEDES story, the government started to move away from good macro policy when Roberto Lavagna, which included several CEDES insiders, left the government at the end of 2005.

On this new position, let me refer again to my previous post (from March 2012) in which I quoted a paper Frenkel presented at a conference organized by Bresser, in which he said:
“the monetary and fiscal policies required to accompany the adoption of a SSCRER target must also have special features: the permanent expansionary stimulus that is part and parcel of the SSCRER heightens the importance of the restraining role to be played by fiscal and monetary policies.”
Let me emphasize this, the notion was that a stable and competitive real exchange rate is so powerful (permanent expansionary stimulus he says, sic) as an instrument for growth that you need fiscal and monetary contraction. Note that devaluation and macroeconomic contraction are the traditional tools of the IMF for countries with balance of payments problems. Part of what I suggested in my previous post is that heterodox authors tended to be more circumspect about the incredible advantages of depreciation. Martín's nuance about disequilibria (fiscal expansion) and not the effects of devaluation on growth are really not clear. If I was confused, he must explain how. Did Frenkel and him changed their position? If so I'm glad, but certainly I'm NOT the one confused here.

His other critique is decidedly bizarre. He argues
"Matías seems to miss the important point that as long as expected depreciation at the exchange rate that the Central Bank is defending is higher than the yield of domestic assets, there would be an excess demand for foreign currency that would eventually lead to the depletion of FX reserves and the collapse of the domestic currency."
First of all, in the post Martín criticizes I say the following:
"Note that if the government on top of the current measures adds fiscal contraction (monetary tightening is a given, since higher rates of interest will be needed to avoid more capital flight; and the effects of monetary contraction can be compensated by subsidized public credit) as the New Developmentalists wanted (since for them inflation was caused by excess demand) then the slowdown will be significant and even a recession could take place."
In other words, yes the government must increase the rate on interest to avoid the expectations of a devaluation. My point indeed was that back in 2012 they should have done that, when the blue was closer to 5, and it was easier to do and avoid a depreciation (which Martín wanted and I didn't) and that he used to think it was good, but now that happened he has second thoughts (you'll see why in a second).

Second, exactly because the problem is the low rates of interest when compared with holding dollars, you see that this is not a problem associated to the exchange rate being overvalued or the current account being unsustainable in the short run. It is something that could have been solved long ago with a higher rate of interest. Mind you, Martín is simply wrong when he says that since 2010 the Central Bank of Argentina was using the nominal exchange rate as an anchor for prices (he is really confused on this one; just check the rate of depreciation), and I should know since I was at the bank at some point during this period (actually Brazil did that, and that explains lower inflation in Brazil).

But here comes the cherry on top of the ice-cream. Why would depreciation still be good for Martín? Because the long-term exchange rate elasticity of exports is actually high. The short-term isn't and that's why in the short run the depreciation will be contractionary and he has some doubts about it. But in the long run things are hunky dory. So here is NOT about imbalances, but depreciation is good for growth because it increases competitiveness and exports (wink, wink, devaluation is not good, but yes it is; and I'm confused!). In his words:
"The problem is that Matías confuses an important distinction between short-run and long-run effects of the real exchange rate on economic performance. In Krugman-Taylor, a real devaluation (a change in the RER) has a negative effect on output and employment in the short run; in Frenkel-Taylor, a competitive RER level has a positive effect on long-run growth."
I guess I missed that class by Lance, and that's the source of my confusion. I should note that I had a few exchanges with Martín on Twitter (see below in Spanish) on which he also suggested that in the long run was good for growth.
Here is the problem, Martín (neither him, nor Frenkel or anybody else as far as I know) has shown this great long-term elasticities that show that depreciation in the long-run (the Frenkel-Taylor, not Krugman-Taylor story) is good for growth. The evidence I cited here (from this paper by Fiorito and Silvio and Nahuel Guaita) actually shows that there is no indication of a positive elasticity in any run. If Martín shows that there is some evidence on positive and significant long-term real exchange elasticities for exports (I'm really interested in what methodology he suggests for finding this result, and separate the short and long run elasticities), like Keynes I will change my mind, and try to prove Eatwell wrong on the role of empirical evidence in economic debates. But if you (Martín) cannot come up with evidence to support your nice theoretical model (the Frenkel-Taylor that rules in the long run, are we clear?!), what should we call you? Confused does not seem the correct definition for someone that keeps defending an idea for which there is no evidence (don't worry, I'm not in the game of name calling).

Finally, I should add here, that while I do think that the government has committed mistakes, and allowing the blue (the black market) exchange rate to depreciate and not hike interest rates earlier  is one of those (I would add the need for a more aggressive Import Substitution policy to reduce the external constraint, something I defended as early as March 2012; see here), I still think that this government should be supported and is much better than the alternative (Martín is certainly not in favor of the government).


  1. NK, what is your take on this:

  2. Matías, I find wierd that someone call Developmentalist something very much like monetarist bp adjustment. I think many fresh economist are really being confused by Bresser and, to my surprise, by Robert Frenkel.
    Anyway, I congratulate you for bringing this about and provide us with an informed discussion.

  3. I think there is a lot of confusion in this discussion.

    Taking a step back, let me share the context to those who do not follow Argentina.

    To a first approximation, Argentina does not have access to external finance. That means that it cannot borrow dollars to pay for its imports or roll over their debts. Under this constraint, any shock (for instance, a slow down in export revenues) that reduces Argentina's ability to earn dollars requires either (a) a drawdown on Argentina's reserves, (b) a reduction in imports.

    To reduce imports, there are 3 ways: (i) reduce absorption, via contractionary monetary or fiscal policies; (ii) substitute towards domestic goods, via a real depreciation; (iii) impose controls or tariffs that make imports more expensive.

    Matias picks on Martin about elasticities. But import price elasticities are large. Even if export elasticities were zero (they are not), a real depreciation helps Argentina avoid adjustment exclusively through (i), which is more painful.

    Wrapping up: Argentina is indeed facing a balance of payment crisis. After all, it has to choose between let the exchange rate go or to engineer a recession.

    It will probably end up with both, but then that is the curse of Latin American populism and inward oriented policies. You can bet the farm it will happen again.

    1. Hi all:
      And sorry for the delay in replying. Yes, the lack of access to external finance is a problem, but note that Brazil brings inflows with high rates of interest. Also, the import elasticity is also insignificant in all evidence I know. Actually what works is also the income elasticity. So devaluations do work because they're contractionary.

  4. Hi Matias, Juan Manuel Telechea here. I made a post about this, giving it a twist: although I agree that the lower yields of domestic assets vis a vis the expected rate of depreciation explain capital flights in Argentina, this only explains why dollars went out but not why they stopped coming in.
    What I mean is that the problem of yield differentials has been going for several years but the huge fall of FX reserves arose only in 2013, why? My point is that in 2013 in addition to the yield differential problem a new one appeared: a severe contraction in the commercial account explained mainly by the cepo. This can be seen by looking at the "balance cambiario" at the BCRA which I show in my post (I think this is better than looking at INDEC's ICA or balance of payment data).
    Note that, as we have our capital account "closed" it doesn't matter the level of the commercial deficit (actually it is still positive) but its variation: in 2013 according to this data the commercial account went from USD 14.700 millions in 2012 to 1.790 millions in 2013, a change of -13.000 millions. If you add this to the tourism leakage you can practically explain the whole FX reserves contraction.
    Here is the link to the post (in spanish):
    Best regards.


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