The macroeconomics of the public sector deficit : the case of Argentina

Policy, Research, and External Affairs -' ' WORKING PAPERS Macroeconomic Adjustment and Growth Country Economics Department The World Bank March 1991 WPS 632 The Macroeonomics of the Public Sector Deficit The Case of Argentina Carlos Alfredo Rodriguez Argentina has had a qIualrter century without growth at a time of rapid econonmic growthi in the rest of thle world - and govern- ment spendi ng systematically grows faster than GDP and exceeds government revenues. Thle cenitral bank borrows about 80 per- cetit of the private banks' lending power. I hc l'ol,;c, Rccar,.h. *dnd 1- xwrnma Al li ir, (u I'- ledc ; dnh..:cs I'RI \ orkueag I'4prc l.u duluennunatc uhe ifudingx uuf work in pruugrecus and iuuu. ua . l '. uF. ~ a x! . x. J s . ;d. .d :r . '. 1'. 1. :' ':u,c ',... dt%u~n'" I I 1c'c P p.;-r% Lan-s !h- ramc. o! d. '.':'.u~u~ I " .~.. . &: .: .-d'.; ' ... ;II I' u'.' " :' ; '.' ': -i, .id'nc81'ounI f.arcLuc d..!.t'. .\N: |! .\ .'.1..''\.: 1 d'' n... ..' .\\ .' ' i"K,. s] .!.'t.'1).V'..': .. '.\ '' .'' ': :' I..' :: ccen mnc- ntne  Policy, Research, and External Affairs _ - aIT - Macroeconomic Adjustment and Growth WPS 632 This paper - a product of the Macrocconlomic Adjustment and Growth Division, Country Econiomlics Departmc1t- is part ofa PRE research project, ThecMacrocconiomics o'ithc Public Sector Delicit (RPO 675-31). Copiesare availalble f'reefroi the World Banik, 1818f iStrectNW,WashlillgtolnDC 20433. Please contact Raquel Luz, room NI 1-057, extensioni 34303 (90 pages). Argentina hias had a quarter century without percent of revenue f'rom creating moncy - the growth at a time of' rapid economic growth in thie eff''ct o 'collectitig which is an additional 67.9 rest ol' the world and government spending percent of inflation. systematically grows fEster than GDP. Spendinig declined when the final crisis of thc Argenltine Public debt plays a peculiar role in economy began in 1982, but more because of' Argentina's finances. The central bank has resource constraints than delibcrate political become the chief borrower ol' about 80 percent action - and too late to avoid the 1'ina Jal crisis of thc private banks' lending power. In this that brought hyperinflation (approaching 5,00(0) context, a policy of tight moncy to reduce percent in 1989). Thc government rani a primary aggregate demand basically increases the tratns- dcf-icit (not including interest paymentis) evcry lers from the public to ihe private sector because y( r from 1961 to 1989, SO it issued money anid of' the highlCI deficit that the rise in interest rates inteirest-bearing debt. As a result, the cconomy generates. expericnced high real interest rates and inflation. The pressure that government debt puts on Despite heavy fiscal prcssurc, fiscal spend- the financial markets is best captured by evaluat- ing has continued to grow, systematically ing that debt at the commercial exchange ratc. exceeding revenues. From 1964 to 1975, the When the stock of'debt gets out of linie with deficit was financed by creating money; witlh thc available reserves, pressures mount against the fall of Peron and the beginning of a military currcncy and devaluation follows. Then thlc regime, debt financing became significanit. remainirng stock of debt rises at rates Far bey(,nd Rodriguez' regression study shows that every I levels consistent with a fixed exchange raltc -- percent of primary deficit is linanced with 0.7 and a new crisis begins to develop. Thc PRE Working Paper Series diss-rninates thc inclings of work under *wa\ in the Bailk's Policy, Research. and Extenal AffairsComplex. Anobjectiveofthcscries istoge tihesefindingsootitquicklv, c\ en ifprcsenta:tionsre less than full\ polished. The Findings, interpretations, and conclusions in thesc papers do not necessarily represcnt official Bank polic\. lP odued h! th ic I'KR. Di)iinmatnon CU cicr  I. INTRODUCTION II. MEASUREMENT OF THE PUBLIC SECTOR DEFICIT IN ARGENTINA II.1 Consolidated Non-Financia' Public Sector II.2 Quasifiscal Expenditures III. THE FINANCING OF THE DEFICIT III.1 Measuring the Inflation Tax III.2 The Fiscal Deficit and the Inflation Tax: Statistical Analysis. IV. PUBLIC DEBT AND THE STRUCTURE OF FINANCIAL MARKETS V. THE DEMAND FOR MONEY AND THE LIMITS TO THE INFLATION TAX VI. PUBLIC DEBT AND INTEREST RATE DETERMINATION VI.1 Short Run Analysis VI.2 -:mpirical Estimates VI.3 Interest Rates and Inflation in the Steady State. VII. THE EXTERNAL EFFECTS OF PUBLIC SECTOR DEFICITS VII.1 Theoretical Framework for Real Lxchange Rate Determination. VII.2 The Trade Balance and the Fiscal Deficit. VIII. GENERAL SUMMARY AND CONCLUSIONS APPENDIX. THE FISCAL DEFICIT AND PRIVATE SAVINGS AND INVESTMENT. (*) I would like to thank the very useful comments and suggestions of Aquiles Almansi, who provided invaluable help for the econometric analysis presented in the Appendix.  I.INTRODUCTION Argentina has had a sad economic history in recent decades. As of '89 real per-capita GDP stays at a level similar to that of the _arly 1960's. This means a quarter of a century without growth at a time when the rest of the world has seen one of the most glowing periods in terms of economic achievements. Per-capita GDP reached a historical level in 1974 and has never again been able to surpass this level in spite of reaching it again in 1977 and 1979. Since 1980 GDP per capita starts a steep decline that results in an accumulated fall of 23.5% in the ten year period 1979-88. During the same decade, the orice level increased by a factor of 3.36 million, equivalent to an annual compound rate of inflation of 349%. It is not our objective to explain the reasons for the economic stagnation of Argentina but to concentrate on the role that public sector behavior may have had in that process. In particular, we shall be concerned with the role of government spending, taxation and deficit financing on the rest of the economy. We shall not be concerned with the effects of government reaulation, a topic that deserves a volume on itself. FIGURE 1 CDP PER CAPITA (1969 PRICES) 75- - I I I I- I I I I I 7S . . . . . . . . . . . . . . . . . . . . . ..... . 65 . . . . . . . . fig . . . . . . 55 . . 50 . .; 45 1969 1965 1978 1975 1989 9985  Government ha' a very important role in Argentine society. It taxes, spen'Ts, produces a wide \,ariety of goods and services, regulates financial markets and supplies financial services, systematically resorts to incomes policies anid regulates foreign trade. While the regulatory aspects of government action defy any possible quantitative measure, we can get a feeling about the size of government in economic activity by looking at the relative participation of government spending in GDP. Figure 2 shows thaL government spending has systematically tended to grow faste- than GDP until the final crisis of the Argentine eccnomy started to develop in 1982. Since then it has started to fall, more as a consequence of a resource constraint than as a consequence of a deliberate political action. FIGURE 2 TOTAL EXPENDITURES OF THE CPS AS PERCENTAGE OF UP 60 so . . . . . . . . . . . . . . . . . . . . .\ 45 . . . . . . . . . . . . . . . . . . . . A .. ... . . 1969 1965 1979 1975 1989 1985 The fall in the relative size of government spending, however, came too late to avoid a crisis that was already well into the working and that brought the country into a state of hyperinflation in 1989, when the inflation rate approached 50OOO and GDP fell by about 7%. The inflation rate in Argentina defies being graphed because of the significant changes in levels reached in the late 1980's. The December to December values of the rate of inflation in the CPI are as shown in Table la, It is clear that inflation has been an ever present phenomenon in recent decades and that it has followed an exploding path, of which the rucent hyperinflation of 1989 does not necessarily 2  appear to be the end of the story. In fact, after the peak of 195% monthly inflation rate in July 1989, inflation goes back to the one-digit monthly level until December 1989. Then a new hyperinflation starts, which reaches a peak of 95% in March 1990 and apparently ends in April 1990 with a monthly rate ot "only" 11.5%. The monthly inflation rates since 1982 can be seen in Table lb. If one were to give a quick characterization of government action in Argentina it would be that government has systematically tended to increase spending and to run deficits. It is well known that governments do not need to run fiscal surpluses all of the time, and much less in the context of a growing economy. The fact of the matter is, however, that the Argentine economy has been stagnant in the last two decades and the government has run fiscal deficits for every year at least since 1961. In fact, the government has run a primary deficit (not including any interest payments) for every year in our sample dating back to 1961. This means that for every year of the last 28 years, after paying for the current and capital spending the government has not had any genuine resource left to service any interest on its debt (internal or external; this issue has been raised by Dornbusch and de Pablo (1987) and by Rodriguez(1989) in the context of explaining the fiscal nature of the country's apparent inability to serve her foreign debt that is mostly public). In onsequence the government has resorted systematically to issu-ing money and interest earning debt. This deficit policy resulted in a systematic tendency of the economy to run high inflation and high real interest rates as a consequence of the pressure in the credit markets of the incremental government borrowing. For an economy that does not grow and faces a positive real rate of interest, running a positive primary deficit implies an ever growing stock of Public debt in relation to GDP. Of course, in an ex-post sense real government debt did not grow continuously because every once in a while the existing stock of debt has been melted down by outbursts of inflation in excess of nominal interest rates fueled by large devaluations in the face of foreign exchange crisis (on the relation between deficits and devaluations, captured by increases in the level or in the rate of change of the exchange rate, see Calvo(1981), Fernandez (1989) and Rodriguez(1978)) 3  TABLF la: ANNUAL INFLATION RATES IN CPI (1961-1989) 16,5 30J 9 23I 30,2 30,0 2?,3 9,b 6,6 21,7 X1 612 4308 III 335, M716 160A 169,8 1N7 8716 131'3 ,1 13317 61,8 I5,4 Bl,9 1714,8 B1, i9D,7 TABLE IB: MONTHLY INFLATION RATES IN CPI (JAN.1982-APRIL 1990) 11.9 5;3 4.7 4.2 3.1 7.9 *W:XStti 16.3 14.7 17.1 12.7 11.3 18.6 '1B^StI 16.9 13.0 11.3 10.3 9.1 15.9 1WlXl 12.5 17,2 21.4 17.08 19.2 17.7 12.5 1?.0 20.3 18.5 ?.1 17.9 1B 18.3 22.8 27.5 19.3 15.0 19.7 25.1 20.7 26.5 29.5 25.1 36.5 1 6.2 3.1 2.8 1.9 2.4 3.2 3.8 1.7 4.6 I.7 4.0 4.5 SI'IsU] 6.8 8.8 7.2 6.1 5.3 4.7 7.6 6.5 8.2 3.4 4.2 8.8 1l