The Fiscal and Monetary History of Latin America 2015-2016

• 1960–1976: Roberto Cortés Conde of the Universidad de San Andrés and Pablo Gerchunoff of the Universidad Torcuato Di Tella
• 1977–1990:  Roque Fernández of the Universidad del CEMA and former president of Argentina’s central bank and former minister of the economy, and José Luís Machinea, former president of Argentina’s central bank, former Minister of the Economy, and former Executive Secretary of  United Nations’ Economic Commission for Latin America and the Caribbean.
• 1991–2001:  Mario Vicens, former president of the Association of Banks and former Secretary of the Treasury, and Pablo Guidotti of the Universidad Torcuato Di Tella and former Secretary of the Treasury.
•  2002–2014: Daniel Artana of the Universidad Nacional de La Plata and Universidad Torcuato Di Tella and chief economist at the Foundation for Latin American Economics Research, and José María Fanelli of the Center for the Study of the State and Society and of the National Council for Scientific and Technical Research.

This preliminary discussion took place in Barcelona, Spain.

The first session of the day focused on Chile and Mexico, the second on Peru and Venezuela, the third on Colombia and Paraguay, and the fourth and final session focused on Ecuador and Uruguay. The organizers of the discussion were Albert Marcet (IAE-CSIC, MOVE, UAB and BGSE) and Juan Pablo Nicolini (Federal Reserve Bank of Minneapolis and Universidad Torcuato Di Tella).

Chile is a small economy open to trade. Its 18 million inhabitants represent just 3 percent of the Latin American population, whereas Brazil, Mexico, and Argentina represent 33 percent, 20 percent, and 7 percent respectively. Its main exports are based on natural resources and, although copper represents the main single export, its relative important has declined over time. In recent decades “nontraditional” exports, like extractive fishing, food products, and cellulose, among others, have gained importance.

Since the late 1980s, Chile has experienced positive and relatively high GDP growth rates. As a result, Chile has the highest per capita GDP (PPP) in Latin America (IMF, World Economic Outlook, October 2014) and was the first South American country to join the OECD (the other Latin American OECD country is Mexico).

Despite the relative economic success in recent decades, Chile, much like its neighboring Latin American countries, has experienced poor economic growth and severe economic crisis in the second half of the 20th century. Analyzing economic data from its troubled era and successful period, in comparison to the economic trajectories of other nations in the region, helps draw lessons from different fiscal and monetary reforms, enacted at different times and circumstances.

The case study for Chile, organized by Rodrigo Caputo, was hosted at the Chilean Central Bank in November 2015. The event brought together both Chilean policymakers and scholars to debate the fiscal and monetary policies implemented in Chile from 1960 to 2010, which are described in the Chilean chapter of the fiscal project book.

Chile in the Late 20th Century

Over the past fifty years, Chile experienced radical economic and political changes. In economic terms, policies shifted from the imports substitution strategy adopted by many Latin American economies in the 1940s to market-oriented policies, in which the role of the state, both as producer and regulator, was greatly diminished. Politically the country, which has enjoyed a relatively long period of political stability since 1925, experienced an important institutional collapse in the early 1970s; three years of a socialist government ended in 1973, after which the military took power, remaining in office until 1990.

Until the mid-1980s, the study of Chile’s modern economic history usually generated a sense of excitement and sadness. It sparked excitement because from 1945 to 1983 Chile has been a social laboratory of sorts, where almost every possible type of economic policy has been experimented. Sadly, to a large extent all these experiments ended up in failure and frustration.

Since the mid-80s onward, the economic developments in Chile have been, however, very different: the economic reforms undertaken in the ’70s and ’80s have continued, and the economy has been on a stable economic path for the last three decades.

Participants in the one-day workshop devoted to discussing the Chilean economic experience in the last fifty years highlighted the main macroeconomic events during specific periods of time and discussed the different policies adopted throughout this period.

High inflation, slow growth and mild public deficits: 1960-1970

During the 1950s, inflation became a serious problem in Chile as well as in other Latin American countries. There was a consensus that inflationary pressures rested on excessive money creation and remarkably lax fiscal policy. Alessandri’s government (1958-1964) launched a stabilization process with the aim of containing inflation and reducing public spending. During the first years of this administration, fiscal deficits could be contained and inflation was reduced to single-digit levels. The stabilization plan was, apparently, a success.

The low level of inflation, however, was not going to last. In 1960 and 1962 the fiscal deficit increased, and a balance of payment crisis induced severe nominal exchange rate depreciation. Soon after the nominal devaluation, prices increased substantially and the nominal anchor role played by the exchange rate ended.

The Frei government (1964-1970) faced challenges similar to the previous administration: to stabilize inflation and to reduce the fiscal deficit. Overall, this administration was able to reduce the fiscal deficit, but failed to contain inflation. The main reason for this was that extraordinary transfers were much more important than before and constituted an important source of inflationary pressures.

Daniel Tapia de la Puente, former Deputy Governor of the Central Bank of Chile, noted that financial repression, in the form of nominal interest rate set well below inflation, constituted a major problem, which precluded the private sector from saving. As a result, fiscal deficits could not be financed by the private sector and at the same time the private sector was unable to obtain credit to invest. Hence, the close link between inflation and public deficits is also due to the absence of alternative domestic source of financing.

Roberto Alvarez, a Chilean economist at the Universidad de Chile, pointed out that a potential raeson for the decline of the fiscal deficit during the late 1960s is related to the improvement in the price of copper and the increase in fiscal copper revenues. The fact that inflation was still at high levels could be related to extraordinary transfers associated to social spending or the cost of the Frei’s land reform.

Hyperinflation and Stabilization: 1970-1978

In 1970, Salvador Allende, a socialist president, took office. His economic program was characterized by several left wing-oriented structural reforms and was implemented almost immediately. The essential assumption of the economic program was that there was substantial unutilized capital capacity in the manufacturing sector. In this context, it was expected that an increase in aggregate demand could be accommodated without generating inflationary pressures in the short run.

Three elements characterize Allende’s government: first, a sequence of increasing fiscal deficits as a result of a substantial increased in social public spending; second, the lack of domestic and foreign financing that induced an important expansion of high-powered money, which became almost the only source of public financing; and third, an inflationary process that became hyperinflation by the end of 1973. As pointed out by Professor Manuel Agosin, from Universidad de Chile, in the 1970-1971 period the large fiscal expansion with relatively mild inflation acceleration, in spite of considerable seigniorage, was the consequence of large excess capacity. In the following period, 1972-73, even larger fiscal expansion with even larger base money creation induced accelerating inflation beyond the point where seigniorage yielded more real revenues.

In September 1973, a military coup overthrew President Salvador Allende’s government. The military regime, led by General Pinochet, reduced the public deficits substantially from 1974 onward. Despite this fact, inflation remained relatively high. The reason behind this is related to the fact that the new government decided to remove price controls after September 1973. As a result, the level of prices increased substantially: in April 1974 the inflation rate (measured as year-on-year variation) increased to more than 700%. In subsequent years, inflation remained high despite the massive fiscal adjustment after 1973.

In terms of the budget constraint exercise, the coexistence of low (almost zero) fiscal deficits and high level of seigniorage is consistent with extraordinary transfers from the government. Professor Raimundo Soto, from the Pontificia Universidad Catolica de Chile, argues that those transfers may well reflect contingent liabilities not included in the priamry fiscal deficit, like pension fund transfers, land reform bonds and nationalization payments. They may also reflect different types of entitlements, like implicit transfers to the armed forces as well as price and wage indexation.

In the following years, 1976 and 1977, the main priority of the military regime was to stabilize prices. The slow progress in reducing inflation, induced policymakers to implement alternative stabilization policies. In particular, a fixed exchange rate regime was adopted in 1979, so at the beginning of the ’80s inflation was stabilized.

Balance of Payment Crisis and the Fiscal Burden of Debt Crisis (1982-1990)

In the context of a fixed exchange rate regime, the existence of wage and financial contracts indexation (to past inflation) induced an important real appreciation. This tended to exacerbate the current account deficit (which was mainly private). In the face of external shocks (the Mexican crisis of the ’80s and the increase in the FED fund rate), the exchange rate regime could not be sustained and was abandoned in June 1982.

The sharp depreciation of the peso in a context of a severe recession made many banks insolvent. They could not recover an important proportion of their credits and, as a consequence were not able to pay back their foreign loans. In order to prevent widespread bankruptcies, the government introduced rescue programs that were implemented, in an important proportion, by the Central Bank. In the end, the private external debt was absorbed by the Central Bank and the Treasury and many of the subsequent fiscal and monetary policies were designed to ensure the external debt was eventually paid.

Professor Rolf Luders of Pontifica Universidad Catolica de Chile, a former Ministry of Finance in the late ‘700s and early ’80s, pointed out that an important reason for the collapse of the fixed exchange rate regime was the prevalence of wage and price indexation. As a consequence of this, wages could not be reduced in the face of negative external shocks, so the devaluation was, eventually, the only way to restore the external balance.

Gabriel Palma, a Chilean Professor at Cambridge University, suggested that a key issue in explaining the collapse of the Chilean economy in the early ’80s is related to the way in which capital inflows were allocated inside the economy. In particular, he argues that excess liquidity was absorbed by the private sector, generating a consumption boom and a real state bubble without increasing the potential output of the economy.

Fiscal Discipline, Fiscal Rules and Inflation Targeting: 1990-2010

Much of the fiscal and monetary policy in Chile post-dictatorship (after 1990) was conditioned by the role played by the Central Bank and the Treasury during the ’80s crisis. In particular, the Central Bank and the Treasury assumed, de facto, the debt obligations of the private sector.

To avoid monetizing the debt and repudiating it, debt obligations were indexed and set to long horizons. Now, those debts have to eventually be paid and the only way to achieve this was by generating fiscal surpluses. This idea, which was present since the mid-1970s, was followed by the Pinochet administration in the late 1980s as well as by all the democratic government that came after. In fact, in each year between 1987 and 2010, the fiscal authority generated a surplus. Net asset accumulation over time by the central government help meeting future public sector commitments that grow at a higher rate than fiscal revenues, and potential expenditures on contingent liabilities. Furthermore, they also helped financing the Central Bank losses due to the carry-over of quasi-fiscal costs of the rescue of commercial banks in the early 1980s and the sterilization of large capital inflows in the 1990s.

An important implication of this strategy is that it enabled the now-independent monetary authority to pursue the inflation targeting regime that is in place today in Chile. This is despite the fact that the Central Bank was experiencing operational losses and has a net worth that steadily declined since the mid-1980s.

A team of economists from Colombia, Ecuador, Mexico, Paraguay and Uraguay gathered in Chicago to share the latest findings in the ongoing study of  the fiscal and monetary histories of these nations.

On August 10, 2016, the Central Bank of Paraguay hosted this workshop in Ascuncion. It was the latest in an ongoing series of workshops that have been taking place in a number of Latin American countries over the last year as part of the Becker Friedman Institute.’s project, “The Monetary and Fiscal History of Latin America.”  This project examines the impact of past aggregate fiscal and monetary policies on the region’s poor growth performance.

During this session, economists and former policy makers gathered to review the economic history of Paraguay within a common theoretical framework followed by teams of economists studying historical data and policies in the nine largest Latin American economies. The objective of the event is to get significant feedback from prominent economists and policymakers on the work undertaken by project members from Paraguay so far.

Carlos Javier Charotti, project leader of the Paraguayan case, presented his work the theoretical framework to analyzing the monetary and fiscal history of Paraguay from 1962 to the present. Charotti divided his discussion of the modern economic history of Paraguay into four periods.

After his presentation, prominent Paraguayan economists joined in a discussion of  every period. Authorities from the Minister of Finance and the Central Bank of Paraguay led each session.

In collaboration with Research Institute for Development Growth and Economics (RIDGE), the institute hosted the next workshop examining the fiscal history of Uruguay at the Central Bank of Uruguay

Researchers present their analysis of 20- and 25-year periods from 1960 through 2014. Presenters include scholars from leading universities and economists from the central bank and other government agencies and institutions.