Econ 452 Final Exam Study Guide
Econ 452 Final Exam Study Guide Econ 452
Popular in Economies of Latin America
Popular in Economcs
This 6 page Study Guide was uploaded by Laura Kunigonis on Sunday May 15, 2016. The Study Guide belongs to Econ 452 at University of Illinois at Urbana-Champaign taught by Werner Baer in Spring 2016. Since its upload, it has received 11 views. For similar materials see Economies of Latin America in Economcs at University of Illinois at Urbana-Champaign.
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Date Created: 05/15/16
INFLATION IN LATIN AMERICA 1. Latin America provides examples of: inflation and growth, inflation and stagnation, price stability and growth, price stability and stagnation 2. Latin American inflation “monetarists” and the “structuralists” 3. Monetarists cause of inflation: budget deficits financed by the central bank inflation causes a misallocation of investment resources – investment in nonproductive sectors (housing, real estate, etc) also tendency to invest in shortgestation type of projects inflation with fixed exchange rates causes balance of payments deficits distortions arising from the combination of inflation and controlled price sector inflation kills capital markets or prevents capital markets to develop negative real interest rates discourages foreign investments illusory profits decline in tax collection RECOMMENDATION: tight credit policies, decrease government expenditures, raise taxes, devalue currency 2. Structuralists I inflation to be viewed in context of urbanizationindustrialization growing urban population increases leads to rise in market demand for food but food supply is inelastic due to traditional rural productive structure leads to rise in urban subsistence costs and thus labor costs this is passed on to higher prices of urban goods – results is inflation in addition, balance of payments problems causes further inflationary pressures attempts to use monetarist policies does not deal with the root of the problem the problem is the archaic rural structure 3. Structuralists II urbanizationindustrialization puts pressure on governments to invest in urban socioeconomic infrastructure However, government revenues do not increase at necessary rate to support new government expenditures Budget deficits financed by Central Bank is thus a way out Inflation is thus an instrument of “forced savings” Stabilization Programs 1. Three or four digit inflation can never be productive 2. IMF stabilization programs were the only ones that prevailed until the 1980s, and their content was simple: monetary and fiscal tightening devaluation wage restraints realignment of controlled prices – “corrective inflation” later on indexing of financial instruments were added Indexation of financial instruments and of exchange rate of wages general indexation leads to “inertial inflation” or “fight for shares” – explains inflation of the 1980s which in some cases developed into ‘hyperinflations’ Heterodox experiments 1. based on theories of inertial inflation 2. Austral Plan of Argentina and Cruzado Plan of Brazil 3. based on new currencies and price freezes based on changes in expectations n Plans did not work due to disappearance of market, and failure to have a fiscal adjustment 4. Recent experiments of stabilization 5. Argentina’s convertibility (or “currency board” plan and Brazil’s “Real” Plan) Brazil’s “Real” Stabilization Plan 1. by June 1994 inflation was at close to 50% a month. 2. 1988 Constitution had builtin inflation bias 3. Use of URV (Real Unit Value) 4. temporary fiscal adjustment 5. in July 1994, “real” was introduced 6. rapid decline of monthly inflation rate 7. high interest rates attract capital inflows and real appreciates 8. immediate explosion of sales due to higher real income of lower income classes 9. higher production 10. but by 1995, appreciation of real caused appearance of trade deficit (combined with lower tariffs) 11. by 19967 dilemma of deficit and high interest rates 12. no permanent fiscal adjustment Argentina’s “Currency Board” Plan 1. New peso 2. Central Bank can only issue new pesos against foreign currency 3. All controls were abolished 4. This broke the back of inflation 5. But government did not eliminate fiscal deficit and instead of borrowing from Central Bank, borrowed abroad 6. Longterm growth of debt was not feasible –breakdown in December 2001 Roots of Inflation in Latin America 1. no independent central bank 2. allows governments not to make explicit distributional decisions 3. so social consensus 4. concentration of income and need to finance urban/industrial complex – and no one wants to pay 5. foreign debt only postponed the day of reckoning 6. Can hyperinflation lead to orthodox stabilization? Will it lead to a new consensus? Bebczuk Inflation Why worry about inflation? It changes relative prices and causes inflationary tax Inflation Tax loss of purchasing power via inflation But who holds cash? Mostly the poor. Result: The inflationary tax hits the poor the hardest, making it a very perverse and regressive burden on this social group. Argentina: Inflationary tax has amounted to about 6% of GDP in 20142015 Nonneutral inflation implies that the increase in the general price level is accompanied by changes in relative prices These (hard to predict) changes affect households’ purchasing power and business profitability: → Uncertainty → Weaker consumption and investment → Lower GDP growth and employment Nonneutrality occurs especially when inflation exceeds a certain threshold (above 10% a year?) Chronic inflation Caused by: Devaluations and Fiscal Deficits Inflation in Tradable v Nontradable prices 1. Tradable Prices Example: International commodities such as oil, metals, crops, coffee Local Price ($) = International Price (US$) * Nominal Exchange Rate ($/US$) 2. Nontradable Prices Goods and services whose transportation cost is prohibitively high Examples: Haircuts, health, education, utilities, labor. Local Price ($) determined by domestic aggregate demand and supply Fiscal deficits and nontradable inflation: Treasury Budget Constraint: Fiscal Deficit = Tax Revenues – Government Expenditure = Δ Monetary Base + Δ Domestic Debt + Δ External Debt Quantitative Equation: M × V = P × Y How to stop Inflation Fixed or managed exchange rate regimes, Fiscal discipline High inflation brings about high volatility in relative prices In order to mitigate this volatility of relative prices, people try to adopt a more stable unit of account (anchor): Dollarization: All prices (even nontradables) track past devaluation Indexation: All prices track past inflation Challenge: How to stop inertial behavior without Answer: Easier under dollarization (just fix the exchange rate) Under indexation, authorities need to reduce inflation expectations. Gradual and credible inflation targeting has been the preferred strategy in these countries Central Bank Independence Diagnosis: Chronic inflation is caused by Executive interference to cover fiscal gaps with monetary expansion • As a reaction to inflationary pressures since the 1970s, a new consensus emerges in the 1990s in favor of higher central bank autonomy • This wave reaches both developed and developing economies Inflation and other CB goals • CB goals include: 1. Price Stability (no inflation) 2. Economic Stability (no business cycles) 3. Exchange Rate Stability (no currency crises) 4. Financial Stability (no financial crises) Paiva Inflation Targeting Monetary Policy Objectives 1. Achieve and maintain a low and stable inflation • Important for sustainable growth and income distribution 2. Limit volatility of the business cycle • booms and crashes have costs and lasting implications 3. Improve or maintain the stability of financial markets Monetary frameworks 1) Exchange Rate Pegs 2) Nonexplicit (Inflation) Targets § there is no precise target for inflation § adjust interest rates or a monetary aggregate according to general assessment of economic conditions: inflation, demand, unemployment... 3) Explicit Inflation Targeting 1. announce a precise inflation objective 2. make inflation projections and monitor expectations 3. adjust instruments to make projection (and expectations) = target some say better name would be “inflation projection” targeting With the collapse of the Gold Standard and of the Bretton Woods System” many countries searching for a new nominal anchor chose to target a monetary aggregate Assuming stable demand for money, this intermediate monetary target would yield price stability... But it didnt! missing money targets and/or inflation objectives led to the virtual abandonment of money targets in the 1980s (only about 20 countries follow it today) Inflation targeting: A framework where the primary and explicit goal of monetary policy is to attain and preserve a prespecified rate of inflation. 1. Set a target inflation rate. 2. Forecast the future path of inflation. 3. Compare the forecast with the target 4. Indicate how forecast will be brought toward target! ***Phillips Curve states that inflation and unemployment have a stable and inverse relationship. According to the Phillips curve, the lower an economy's rate of unemployment, the more rapidly wages paid to labor increase in that economy. Effectiveness of inflation targeting Corbo and SchmidtHebbel (2001) compare the implementation and performance of inflation targeters around the world, including Brazil, Chile, Colombia, Mexico and Peru. They find that: most inflation targeters succeeded in bringing inflation down around the year of adop%on of the regime they were successful in a Taining their targets levels they exhibit sacrifice ratios and output volatlity that are lower after the regime is implemented AGRICULTURE IN LATIN AMERICA 1. Large % of labor force in agriculture and a decreasing % of Agriculture in GDP. 3. Food is a high % of family budget 4. Productivity in agriculture is low in most countries (show transparencies) 5. Agricultural growth has been on the extensive margin 6. Agriculture was neglected until the 1970s, only 12% of investments went into it 7. High degree of concentration of land ownership (show table) 8. Functions of agriculture subsistence provide food for cities provide investable surplus for other sectors foreign exchange energy 9. Role of agriculture in Europe prior to industrial revolution 10. Role of agriculture in Ricardo and Lewis models 11. Barriers to agricultural modernization attitude of ladifundia and minifundia to innovation and risk lack of adequate infrastructure lack of adequate extension services marketing monopolies lack of feeder roads, storage facilities inadequate education and health inadequate credit facilities THE LATIN AMERICAN DEBT CRISIS 1. OPEC quadruples oil prices in late 1973 2. Impact on oil importers: case of Brazil recent high growth experience opted for debtled growth 3. petrodollars of banks 4. borrowing to finance import substitution and export diversification 5. lending was good business for international banks lending above LIBOR commissions for large banks 6. in 1979 renewed oil shock, followed by an even more severe interest rate shock 7. leads to Mexican debt crisis of 1982, which rapidly spread to rest of Latin America Mexico, example oil exporter borrowing in future oil earnings, but ultimately faced the same fate as oil importers 8. most LA countries forced by creditor banks to follow IMF austerity dictates in order to rollover debt 9. all this led to the “lost decade” of the 1980s 10. examination of 3 “guilty” parties borrowing countries banks governments of creditor countries
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