The Central Bank and the Government Throughout The

The Central Bank and the Government Throughout the

Last Quarter of the 20th Century: The Case of Argentina

Hernán E. Gil Forleo[1]

Universidad Argentina de la Empresa

Economic History Society

Annual Meeting 2012

SaintCatherineCollege

OxfordUniversity

March 30th – April 1st

United Kingdom

Abstract

The Monetary History of Argentina

Twenty Five years of Economic History, or a Century?

Inflation: a local custom legacy from an exhausted model, 1973-76

Discrecionality and Weak Institutions, 1976 – 1985

Monetary Policy and Structure’s rigidity, 1976 - 77

The Financial System Reform, 1977

Orthodoxy and Crawling Peg, 1977 - 1981

Disequilibrium, external crisis and inflation, 1982-85

Autonomy and Institutionality, 1985-2002

Heterodoxy and Diffuse Boundaries, 1985-91

Structural changes, International openness and monetary policy rules, 1992-2002

Lessons from Argentina’s Economic History

Conclusions

Bibliography

Official Publications

Abstract

Since the depletion of the schemes of nationalization of deposits (1977), to the end of the Currency Board and the Second External Debt (2002), the Central Bank of Argentina periodically changed their functions, instruments and targets of monetary policy, being a key player in the adjustment plans (Australito & Primavera), and stabilization programmes (Tablita) and economic growth (Austral), unilateral trade and financial openness (Currency Board), varying degree of dependence on the government decisions. The purpose of this work is to determinate the participation and evaluate the performance of the Central Bank in the last quarter of the twentieth century: In the first section we will analyse the transition from and scheme of nationalization of deposits to a Free Banking System guaranteed by the government (The Tablita), the second section develop the attempts to stabilize prices and outputs under the first debt crisis, while the third section corresponds to the Central Bank’s role in the scheme of unilateral liberalization and the fixed exchange rate (The Convertibility Plan).

The Monetary History of Argentina

This work attempts to increase scientific work in a little-known research line and sparsely used in the recent Argentina’s monetary history: the aprioristic method rather than other methods (e.g. cliometry) whose use is common in the investigations of the argentine economic history[2], as well as to contribute to the scarce research encompassing periods recent exceeding the validity of stabilization plans and their corrections[3].

And so, what is the purpose of our work?[4]

First, establishing in that measure the link during the quarter century under study was decisive for the success or failure of various attempts to adjustment and stabilization prices.Second, will be the evolution of qualitative restrictions (inflationary habits, democracy) and quantitative (external opening, Balance of Payments crisis) that allowed the CB to execute monetary policy with bias towards the rules or discretion. In third and last place, will be to establish the institutional evolution of the Central Bank (in later CB) as an autonomous organization in the implementation of monetary policy and its association with the inflationary paths that characterize the period under analysis, which has a turning point in the relationship in the year 1985: the principle of autonomy of the CB.

The first subperiod corresponds to the years 1977 - 85, during which monetary policy decisions corresponded to the Federal Government, relegating the CB to be only a mere executor of the same. This period that we call Discretion and Relaxation Institutional, except for brief intervals is characterized precisely in the constant exercise of discretion in the implementation of such a policy, mainly in the issuance of currency to cover budget deficits in the public sector, as well as the interference of the Government in the management of financial risks; the results were not unrelated to the previous experiences (1946-76): inflation and Balance of Payments crisis, this last greater than the previous ones, because the effect of the unilateral opening on a high public weight and closed economy.

The next period: Autonomy and Institutionality (1985-2002), has the hallmark for the first time in its history as a public institution, the CB acquires the decision-making autonomy to run monetary policy set forth explicitly and establishing rules for financial assistance to the Government. The beginnings of autonomy consisted of decision-making disposition of the Government in the establishment of the objectives of monetary policy and the limits compatible with the objectives of the Government: the balance of public accounts.

Twenty Five years of Economic History, or a Century?

Since the enactment of the Act Nº 21.495 of Decentralization of Deposits, the Act Nº 21.526 of Financial Institutions and the ActNº 21.572 corresponding to the Account of Monetary Regulation(in later AMR) during the first quarter of 1977, until the repeal of the Convertibility of the AustralLaw Nº 23.928 and the modification of Act Nº 24.144 Charter Law and GeneralRegime of the Central Argentina Republic Bank in the first days of 2002the CB lived with:

• Central plans of adjustment and stabilization of prices: 1) The gradual implementation[5] d of the Monetary Approach of the Balance of payments in two stages: a) the monetarist phase through the use of monetary aggregates (M1 and M3) as objective during the period 1977 – 78, and ; b) the Stabilization Plan of December 20th, 1978, also known as "La Tablita" which, based on the course of inflation convergence with respect to the Developed World[6] determined the growth of prices under the scheme of an active crawling peg, it covered the period between 1978-81; 2) The Austral Plan (1985), which on the basis of a strategy of shock or eleven for all budgetary balance using the seigniorage under the objective of zero fiscal deficit used price controls to remove the inflation that accelerating the price-wage spiral, an Heterodox Plan that reflecting the heyday of Latin American Structuralism, and; 3) The Currency Board Impure (1991)[7], a return to the principles of the Gold Standard during the Belle Epoque, but this time with the dollar as a reserve value.

• Corrective transition plans: Implemented during the changes of Government or to dilate the institutional crisis. These were three: 1)The Counter-Reformation, measures implemented by Authoritarians Governments aimed to minimize the impacts of imbalances in the period 1977-81, reversing the reforms of opening of goods and capital (1981-82), deepening through the liberalization of prices (1982) and returning to the Classic Economic Policy of Argentina for the second half of the Twentieth Century (1982-85)[8] ; 2) Bounded Structuralism, Australito (1987) and the Ppring Plan (1988), aimed at partially solve macroeconomic imbalances through adjustment of relative prices allowed by the Government, and; 3) The Orthodoxy at the wrong time, while maintaining the basic economic policy of 1989, the Tax Adjustment to Growth Plan (1999) and Frozen Expenses & Debt Structuring (2001) were applied at the wrong time, the first reversing the economic recovery and the second, boosting the replacement of assets, capitals outflow and exchange rate delay.

• Two Debts Default: The first was in 1982, originated by the combination of declines in the terms of trade and a sharp increase in international interest rates, Latin America's economies receiving capital since the middle of the 70s were unable to serve their debts by the primary fiscal surplus or the refinancing voluntary markets for maturities of debt; while the second default in 2001[9], was also a combination of factors, but with greater internal weighting, the degrees of freedom that had the policy of then were scarce: fiscal imbalances, deterioration of the real exchange rate, contractual rigidities of prices and wages incompatible with exchange rates fixed and persistent unfavorable external shocks since 1997[10].

• Two Debt Restructuring: In 1992, Argentina achieves a voluntary agreement of reduction and restructuring of its foreign debt in default through the so-called Brady Plan, while in 2001 the voluntary agreement was the restructuring of capital and the lengthening of the maturity of debt short term whose service was normal.

• Unsustainable inflation: The average annual changes for the CPI index between 1977 and 1988 was 257%, as a prelude to the hiperinflations in 1989 and 1990, years in that such variation amounted to 3.079,5 % and 2.314% respectively.

• Inflation similar to the OCDEs Countries: Upon implementation of the Currency Board and then the pass through effect (14 months), the annual average inflation between 1993 and 2001 was 1.05%, with a maximum monthly 1,2 % and minimum - 0,7%.

Inflation: a local custom legacy from an exhausted model, 1973-76

Nothing more than Argentina of being a distant country to implement Keynesian paragons and theories Centre - Periphery and Impoverishing Growth[11] to dominant of Latin American thought since the end of the Gold Standard, relegated the importance of monetary policy to the background. A clear example of the application of these theories as well as the power of discretion of the Government lies in the organic Charter of 1973[12], which established their functional dependence on the Government (Art.1º), changes the priority for the achievement of its objectives (Art.3º, inc.a):”…create conditions for maintaining an orderly and growing economic development with social sense", then for " keep the the purchasing power of the money". Lacking decision-making autonomy to run monetary policy: "...The performance of the Bank shall be subject to the directives handed down by the national Government, through the Ministry of economy, in economic, monetary, exchange rate and financial policy…” (Art.4º), and indirectly delegating to the Government the possibility of limiting the actions of the CB to submit the budget for wages payment. (Art.14º, inc.b.)

The CB discretionality can be subdivided into two segments:

• Limited to the CB and Treasury Balance Sheet:Taking the art 29º, "The Bank may make temporary overdrafts to the Government, to an amount that does not exceed 30 per cent of the resources in cash that it has obtained in the past twelve months.All advances made by such a concept should be reimbursed within twelve months of incurred. If any advancement of this nature would be non-payment after that deadline, you can not return to use this power to the Bank until the sums due have been reintegrated. "On these developments the Government will pay an interest to be agreed with the Bank, not higher than the minimum rate of discount window in force. Put another way, the Government could request financial assistance equivalent to a full quarter of tax revenues during the last 12 months. Being this restriction an average cell phone, any increase in public revenue by the inflation tax, it allowed again request assistance to stay the restriction under the maximum permitted limit; While article 51º allows another source of discretionary funding for the public sector belonged to the value of the total of deposits the Bank may have in its portfolio public securities whose amount does not exceed of thirty-five percent (35%) of the total of deposits received by banks, on behalf of the Central Bank.

• Unlimited to the magnitude of the fiscal deficit: (Art.18º inc.i) "..."Buy and sell in the market public securities for the purpose of regulation, “The Bank may invest in these operations up to 15% of the amount in circulation of the public values with current trading on the market, but such limit may be extended through the allocation of special reservations or, in cases of emergency, with the unanimous vote of the members of the CB Board…"

Following the described paragons, the Government closed the domestic market to the competence, allowing the existence of a structure of offer, composed by public monopolies in the sector services and mixed monopolistic competition in the production and trading of goods, tending to distort domestic prices which enhance the swings in the Balance of payments; in turn, they compensated by increases in public spending - financed monetary emission -, when it was impossible that the economic policies adopted avoided intertemporal consumption substitution giving rise to contractionary phases of the business cycle. Initial increases in the supply of real balances and decrease in demand in an economy whose external sector ranged from high Regulation (current account) and closing (capital account), had dual effect: partially increase the consumption - by the decline in the real interest - and raise prices, by the combined effect of closure to the flow of capital, fiscal deficit and supply aggregate structure of the market, determining the relative prices.

The consequence of this conduct imposed on the Monetary Authority is easily deductible in quantitative terms as we did in the preceding paragraph: the emergence of the inflation phenomenon that constantly distorting relative prices. But rarely in the monetary history Argentina stands out the qualitative relevance as a result of this phenomenon:

• The first phenomenon corresponds to the CB: the financial system lacked during more than three decades of a CB. Was absent the function of preserving the value of the currency and the supervision of entities and, was present of lender of first resort by the Government, whilethey alienated practices manage risks in financial institutions.

• The second, to the individuals: daily living with inflation, the habit of optimizing consumption with negative real interest rates as well as maintain its portfolio fixed assets (houses and apartments) in greater proportion and, on the other hand, in the formation of expectations, resulting in adaptives because the high inflation index from 1973 onwards.

• The third and last phenomenon correspond to the Government: The custom of finance budgetary imbalances by means of issuing currency, allow the existence of structures of production away from the competition to be the domestic production[13] to meet domestic demand distorting relative prices, and to use the CB to ensure coverage of the various risks in economic and financial (e.g. Corporate non quantifiable risk to select the bank where deposit funds, as the Government through the CB guaranteed the return of the same). The existing institutional structure, mainly the relationship between the Government, the CB and the financial system, as a result of the nationalization of deposits and the addressing of the credit, to the discretion of monetary policy distorting mechanisms of natural transmission of this constituting the banks, which lacked the Customs to manage risks, which were guaranteed (not managed) by the Government.

To pass the time, Customs will make inapplicable the adjustment gradual forcing the adoption of stabilization shocks not expected.

Discrecionality and Weak Institutions, 1976 – 1985

Monetary Policy and Structure’s rigidity, 1976 - 77

The economic plan of April 2nd 1976, had among its objectives to reverse the prevailing Crowding Out , meaning in the monetary field: 1) minimize the distortions of Government’s power over the inside exchange value – domestic prices and inflation – the value for allocation resources – real interest rate – and the value that reflected the abroad exchange – exchange rate –, and; 2) Restore the CB as executor of monetary policy.

Prior to the attempts of stabilization which contained a theoretical framework clear – monetarism – latent hyperinflation (1976) and the persistence of the lagged inflation (1977), was approached by the Government (and not by the CB) through price liberalization and the crawling peg passive scheme so that, through the contraction of domestic demand, decrease inflation whose fall would continue as the gap in the public finances was closed in the capital market, and through the promotion of competition with the unilateral opening to foreign trade flows. However, at the end of the 1st quarter of 1977 was necessary to sign a truce of prices between the Government and firms in order to avoid the appearance of the inflation phenomenon. The question was why inflation didn't truce? On the one hand, the rates of expansion of the monetary aggregates were all higher than 100%[14]; and on the other, the beginning of the reform of the financial system in this period generated the required uncertainty so that, in a recession economy which began to the dollarization process, the issue moved at one faster rate; These two causes offset the efforts of external openness and reduction of the public deficit.

Although the validity of Act Nº 20.539, it was expected a passive role in the management of monetary policy, the conduct of the CB shows that this was not the case, and that it can assign an active (and Government’s dependent) role; prior to the reform of the financial system, the Monetary Authority adopted the following measures:

• Increase in the required maturity for loans from abroad, to minimize fluctuations in the monetary market of the external sector and reduce the inelastic in the domestic interest rate on the foreign resources.

• Allow the acquisition of foreign currency, which coupled with the determination to the interest rate by market forces, acted as limit in fact the acceptance of excess domestic currency by the public, to have allowed the diversification of financial asset

• When running a crawling peg passive allowed the tradable sector to keep domestic purchasing power and avoid speculation about abrupt exchange rate devaluations.

• Use Treasury Bills auctions fixing the coupon rate to estimate the expected inflation.

• Decrease up to cancel CB’s guarantees repo operations and begin to phase out some of the coverage of risks by the Government in the financial operations promoting banks takes risk.

Crawling peg passive came to an end with the implementation of Financial System’s Reform in June 1977 and the change in the auction’s method of the Central Bank: auctioning Treasury Bills by tender fixing only the funds to absorb; the time of monetarism had come.

The Financial System Reform, 1977

Before the changes of Monetary Policy Instrument[15]and pursuant to provide a greater degree of individual economic freedom, the Government carried on a complete reform of the Financial System.

The new system would have as object return to financial institutions their financial intermediation function and the regulation of the money supply process made simpler through two monetary policy instruments: a) The implementation of reserves requirements, and; b) The Open Markets Operations (OMA);Replacing the instruments used under the system of centralization of deposits:a) Overdrafts lines with limits to its issue options and over the guarantees assigned, and;b) Arbitrary selection of resources allocations, relegating to a lower order, the sustainability of credit assigned.