What Can We Learn From the Current Crisis in Argentina?

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1 What Can We Learn From the Current Crisis in Argentina? Timothy J. Kehoe University of Minnesota and Federal Reserve Bank of Minneapolis June

2 The economy of Argentina finds itself submerged in a great depression that, even if though began four s ago, deepened after mid 2001 with average quarterly falls of deseasonalized GDP with respect to the previous quarter of 5 percent for the last two quarters of 2001 and the first of This violent deepening of the recession occurred just at the moment that economic agents, almost universally, became convinced of the impossibility of sustaining the Convertibility Plan. Dirección Nacional de Coordinación de Políticas Macroeconómicas, Secretaría de Política Económica (2002)

3 What Happened in Argentina in ? The Brazilian devaluation did not lead to problems for the Argentinian current account both exports and the trade surplus in fact grew. March : President De la Rúa rejected the plan presented by the Minister of the Economy, Ricardo López Murphy, to reduce the fiscal deficit. After López Murphy s resignation, De la Rúa appointed Domingo Cavallo, the architect of the Convertibility Plan during the first Menem administration, as Minister of the Economy.

4 Cavallo presented a new economic plan in the lower house of Argentina s congress. On 28 March 2001, the congress refused to allow Cavallo to cut government salary and pension costs, and the government sold debt to cover the deficit. Cavallo s alternative: La Ley de Déficit Cero (Zero Deficit Act): Quasi Monies. In December 2001, the government defaulted on its debt and, in January 2002, it abandoned the Convertibility Plan.

5 Money Market Interest Rates percent per pesos deposits 10 dollar deposits

6 Trade in Goods and Services exports percent GDP imports

7 Inward Foreign Direct Investment Chile 10 percent GDP Argentina

8 Overall Government Balance (Including Off Budget Items) 4 2 percent GDP

9 Argentina External Debt/GDP percent

10 Argentina-U.S. Real Exchange Rate rer log(rer) rern

11

12 Great Depressions of the Twentieth Century Project Use growth accounting and applied dynamic equilibrium models to reexamine great depression episodes: United Kingdom (1920s and 1930s) Cole and Ohanian Canada (1930s) Amaral and MacGee France (1930s) Beaudry and Portier Germany (1930s) Fisher and Hornstein Italy (1930s) Perri and Quadrini Argentina (1970s and 1980s) Kydland and Zarazaga Chile and Mexico (1980s) Bergoeing, Kehoe, Kehoe, and Soto Japan (1990s) Hayashi and Prescott (Review of Economic Dynamics, January 2002 revised and expanded version forthcoming as Minneapolis Fed volume)

13 Lessons from Great Depressions Project The main determinants of depressions are not drops in the inputs of capital and labor stressed in traditional theories of depressions but rather drops in the efficiency with which these inputs are used, measured as total factor productivity (TFP). Exogenous shocks like the deteriorations in the terms of trade and the increases in foreign interest rates that buffeted Chile and Mexico in the early 1980s can cause a decline in economic activity of the usual business cycle magnitude. Misguided government policy can turn such a decline into a severe and prolonged drop in economic activity below trend a great depression.

14 Applied dynamic general equilibrium model The representative consumer maximizes t log (1 )log( ) t = β γ C 1980 t+ γ hnt Lt subject to Ct + Kt +1 Kt= wl t t+ ( rt δ ) Kt. Feasibility: α 1 α t t+ 1 t t t t. C + K ( 1 δ ) K = AK L

15 Argentina: Real GDP per working age person index (1900=100)

16 Real GDP Per Working Age Person and Total Factor Productivity GDP index (1970=100) TFP

17 First order conditions: Calibration 1 C t 1 β = F1+ r I t C HG δ K J t γ γ w = hn L C 1 t t t t. Estimate β =096., γ = data.

18 Model with Adjustment Costs where C + X = AK L 1 t t t t α t α K = (1 δ ) K + φ( X / K) K + 1 t t t t t ( X/ K) 1 η( X/ K) η φ = δ + ( η 1) δ / η. For 0< η 1, φ '( X/ K) > 0, φ''( X/ K) 0, φ( δ) = δ, φ'( δ ) = 1. The model without adjustment costs is the special case η = 1. In numerical experiments η = 0.8. Should we model rigidity in the labor market (instead)?

19 Real GDP per Working- Age Person Base Case Model Model with Adjustment Costs model model index (1970=100) data index (1970=100) data

20 Hours Worked per Working-Age Person Base Case Model Model with Adjustment Costs data hours per week 24 data hours per week 24 model 22 model

21 Capital-Output Ratio Base Case Model Model with Adjustment Costs data ratio 2.8 data ratio model model

22 Investment Rate Base Case Model Model with Adjustment Costs data data investment/gdp investment/gdp model model

23 Mexico: One-sector growth model t maximize β [ γ log C + (1 γ)log( hn L) ] t= 1988 t t t subject to C + K 1 K = wl + (1 τ )( r δ ) K + T X feasibility constraint t t+ t t t t t t t t C + K 1 (1 δ ) K + X = AK L. α 1 t t+ t t t t t A t and X t are treated as exogenous.

24 Real GDP per Working Age (15-64) person and TFP in Mexico = GDP 95 TFP

25 no tax reform constant trade balance data data model 90 model trend TFP 120 taxes/trade balance/tfp model model data data

26 REAL EXCHANGE RATE RER NER P us P ar units : pesos dollar dollars/u.s. basket pesos/argentine basket Argentine baskets U.S. basket Suppose P ar NER P T us (law of one price) T T RER N P T ar P us P us/p us PT us P ar P ar /P ar RER N is the part of the real exchange rate explained by the relative price of nontraded goods.

27 What is left over in RER is the real exchange rate for traded goods: Notice that RER T NER P T us T P ar RER RER T RER N log RER log RER T log RER N rer rer T rer N TRADED Agriculture, Mining and Petroleum, and Manufacturing NONTRADED Construction and Services

28 Mexico-U.S. Real Exchange Rate = RERN 70 RER

29 MODEL Consumers max t 0 t c Tt n t 1 c Nt n t 1 / subject to p Tt c Tt p Nt c Nt a t 1 w t t 1 r t a t T t a t A where a t q t 1 k t b t, k 0, b 0 given Here t is working-age population and n t 0.5 t 0.5pop t is adult-equivalent population.

30 Production functions Domestically produced traded good y Dt min z TD /a TD, z ND /a ND, A D k D Dt Dt Nontraded good y Nt min z TN /a TN, z NN /a NN, A N k N Nt Nt 1 D 1 N Investment good i t Gz TIt 1 z NIt Armington aggregator y Tt M x Dt 1 m t 1/

31 Market clearing Domestically produced traded good x Dt x Ft y Dt Composite traded good c Tt z TIt z TDt z TNt y Tt Nontraded good c Nt z NIt z NDt z NNt y Nt Investment good k t 1 1 k t i t Factor markets k Dt k Nt k t, Dt Nt t

32 Balance of payments m t b t 1 p Dt x Ft 1 r t b t Foreign demand x Ft D 1 Ft p Dt 1 1 Transfer of tariff revenue T t Dt m t

33 Profit maximization Domestically produced traded good w t p Dt a TDt p Tt a NDt p Nt A D 1 D k Dt / Dt D 1 r t p Dt a TDt p Tt a NDt p Nt A D D Dt /k Dt 1 D 1 q t /q t 1 Nontraded good w t p Nt a TNt p Tt a NNt p Nt A N 1 N k Nt / Nt N 1 r t p Nt a TNt p Tt a NNt p Nt A N N Nt /k Nt 1 N 1 q t /q t 1

34 Investment good p Tt q t G z NIt /z TIt 1 p Nt q t 1 G z TIt /z NIt Armington aggregator p Dt p Tt M c Tt z Tt x Dt 1 1 Dt p Tt 1 M c Tt z Tt m t 1 where p Tt 1/M pdt Dt 1 1

35 CAPITAL ADJUSTMENT FRICTIONS i Dt 1 i Nt 1 Gz 1 Tt z Nt k Dt 1 i Dt 1 /k Dt k Dt 1 k Dt k Nt 1 i Nt 1 /k Nt k Nt 1 k Nt i/k 0, i/k 0,, 1 i/k 1 i/k 1 /, 0 1 Adjusting the sector specific capital stock rapidly is costly. Capital in the traded goods sector has a different price, q Dt, than capital in the nontraded goods sector, q Nt. (In simulations 0. 9.)

36 LABOR ADJUSTMENT FRICTIONS Dt 1 Dt Nt 1 Nt There is a limit to how fast sector specific labor can adjust. Labor in the traded goods sector receives a different wage, w Dt, than labor in the nontraded goods sector, w Nt. (In simulations )

37 SUDDEN STOP! b t b t 1 b, t T,...,T N Domestic interest rate is endogenously determined, although interest payments on foreign debt b t are made at international interest rate.

38 REAL GDP Y t p Dt0 y Dt p Tt0 z TDt p Nt0 z NDt p Nt0 y Nt p Tt0 z TNt p Nt0 z NNt Dt m t REAL INVESTMENT I t p Tt0 z TIt p Nt0 z NIt REAL CAPITAL STOCK K t 1 1 K t I t TOTAL FACTOR PRODUCTIVITY TFP t Y t K t Dt Nt 1

39 Trade Balance 4 2 percent GDP data model

40 Real GDP per Working Age (15-64) person and TFP in Mexico Model = GDP 95 TFP

41 Real Exchange Rate = data 70 model

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