Monetary and Fiscal History of Peru 1960-2017 · Monetary and Fiscal History of Peru 1960-2017 Radical Policy Experiments, Inﬂation and Estabilization César Martinelli1 Marco Vega2

Monetary and Fiscal History of Peru 1960-2017Radical Policy Experiments, Inflation and Estabilization

César Martinelli1 Marco Vega2

1George Mason University 2Central Bank of Peru and PUCP

Disclaimer: The views expressed here are those of the authors and do notnecessarily represent those of their institutions.

Encuentro de Economistas BCRP October 31, 2018 1 / 33

Contents

1 Overview

2 Growth accounting

3 Fiscal accounting, public debt and seigniorage

4 The onset of inflation

5 Supply shocks, policy follies and hyperinflation

6 Stabilization and its aftermath

7 Conclusions


Overview

Inflation in Peru in the last half centuryI history of low inflation with periodic bouts of two digit inflationI chronic, accelerating inflation since the mid 1970sI hyperinflation in the second half of the 1980sI successful stabilization of the 1990s

hyper stagflation: hyperinflation accompanied by great depression

we provide a monetarist interpretationI inflation before 1990 reflects the fiscal need for inflationary taxationI stabilization corresponded to a fall in seigniorage to negligible levels

consistent with regime change

political economy: why were those policies adopted?


Overview







Overview







Overview







The big supply shock

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●●Phase 1 Phase 2 Phase 3

19756,002

8,103

10,938

14,764

17,154

1960 1970 1980 1990 2000 2010 2017

GD

P p

er c

apita


Inflationlogarithmic scale

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19750.2%

2.0%

10.0%

37.0%

100.0%

300.0%

7481.7%

1960 1970 1980 1990 2000 2010 2017

Infla

tion

rate


Fiscal deficit

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0%

4%

8%

12%

1960 1970 1980 1990 2000 2010 2017

Fis

cal d

efic

it


Contents

1 Overview

2 Growth accounting





7 Conclusions


Growth accounting

Great depressions (Kehoe and Prescott)

ln yt = (γ − 1)t +1

1− θln At +

θ

1− θln(kt/yt ) + ln ht ,

output per worker = sum of trend and stochastic productivity, capital tooutput ratio, and hours worked (in logs)


Growth accounting: 1960-2010ln

(inde

x)

1960 1970 1980 1990 2000 2010

−0.

4−

0.2

0.0

0.2

0.4

0.6

0.8

lnyt

γt +1

1−θlnAt

θ

1−θln

kt

yt

lnht


Does policy explain the slump?

radical reforms of the 1970s may have lead to massivemisallocation:

I crowding out of financing for private sector and misallocationinduced by selective policies

I inefficiency of state owned enterprisesI cyclical deep cuts in public investment affecting quality of

investment

high to hyperinflation contribution:I waste of real resources in dealing with extreme price and exchange

rate variabilityI price dispersion


Does policy explain the slump?

radical reforms of the 1970s may have lead to massivemisallocation:

I crowding out of financing for private sector and misallocationinduced by selective policies

I inefficiency of state owned enterprisesI cyclical deep cuts in public investment affecting quality of

investment

high to hyperinflation contribution:I waste of real resources in dealing with extreme price and exchange

rate variabilityI price dispersion


Do terms of trade explain the slump?Terms of trade and growth

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19754.0

4.2

4.4

4.6

4.8

1960 1970 1980 1990 2000 2010 2017

Term

s of

trad

e


Contents

1 Overview

2 Growth accounting





7 Conclusions


Government financing

Budget constraint equation (Kehoe-Nicolini-Sargent)

∆θnt + ∆θ∗t ξt + ∆mt + mt−1

(1− 1

πtgt

)= dt + θn

t−1

(Rt−1

πtgt− 1

)+ θ∗t−1ξt

(r∗t−1

πwt gt− 1

)


Government financing and selected components

Total financing

∆θtn + ∆θt

∗ξt + ∆mt+mt−11−

1

πtgt

Foreign debt financing∆θt

∗ξt

Inflation tax

mt−11−

1

πtgt

−10%

−5%

0%

5%

10%

15%

1970 1980 1990 2000 2010 2017

Per

cent

age

of G

DP


Public debt

Total debt

Internal

External

0%

25%

50%

75%

100%

1970 1980 1990 2000 2010 2017

% G

DP


Public debtConstant real exchange rate

Total debt

Total debt (constant ξT)

T = 1990

25%

50%

75%

1970 1980 1990 2000 2010 2017

% G

DP


Fiscal deficit and government financing

Debt change

Fiscal deficit

0%

10%

1970 1980 1990 2000 2010 2017


Imputed transfers

___ Inputed transfers

− − − Privatization procceeds and change in financial assets

Information on some transfers−10%

−5%

0%

5%

10%

1970 1980 1990 2000 2010 2017

Imputed transfers Privatization proceeds and change in financial assets


Contents

1 Overview

2 Growth accounting





7 Conclusions


Belaunde administration

except for brief episode in the 1940s, first democratic regime inPeru in decadesincreased spending on education and roads, among othersmodernization of fiscal institutions

“war of attrition” between President and Congress leads to fiscaldeterioration and inflationary financebalance of payment crisis and devaluation of 1967economic crisis, unfulfilled promises (land reform, IPC conflict)lead to military coup


Belaunde administration

except for brief episode in the 1940s, first democratic regime inPeru in decadesincreased spending on education and roads, among othersmodernization of fiscal institutions

“war of attrition” between President and Congress leads to fiscaldeterioration and inflationary financebalance of payment crisis and devaluation of 1967economic crisis, unfulfilled promises (land reform, IPC conflict)lead to military coup


DevaluationsPercentage increase in official exchange rate

1960 1965 1970 1975 1980 1985

050

100

150

200

250


The military regime

el “gobierno revolucionario de la fuerza armada” (1968-1975)

social democracy with full participation = military dictatorshipland reform, and nationalization of private firms in oil, fishing,mining, food processing, and manufacturingextensive import controls

increase in public spending in large investment projects (mining)and arm raceinflationary finance and debt accumulationadverse terms of trade lead to balance-of-payments difficulties

“la segunda fase” (1975-1980):I IMF supported stabilization plan: devaluation + cuts in public

investmentI unpopularity of regime leads to new elections


The military regime

el “gobierno revolucionario de la fuerza armada” (1968-1975)social democracy with full participation = military dictatorship

land reform, and nationalization of private firms in oil, fishing,mining, food processing, and manufacturingextensive import controls





The military regime

el “gobierno revolucionario de la fuerza armada” (1968-1975)social democracy with full participation = military dictatorshipland reform, and nationalization of private firms in oil, fishing,mining, food processing, and manufacturingextensive import controls





The military regime






The military regime






Expenditure of central government and state-ownedenterprises

0%

10%

20%

30%

1970 1980 1990 2000 2010 2017

Per

cent

age

of G

DP

Central governmentState−owned enterprises


Capital expenditure of state-owned enterprises

0%

2%

4%

6%

1970 1980 1990 2000 2010 2017

Per

cent

age

of G

DP

General governmentState−owned enterprises


Military spendingAn arm race

0.0%

2.5%

5.0%

7.5%

1960 1970 1980 1990 2000 2010 2017

Per

cent

age

of G

DP

ChilePeru


Contents

1 Overview

2 Growth accounting





7 Conclusions


Return to democracy

Belaunde’s second term 1980-1985hit by adverse shocks:

I drying out of foreign financeI worsening interest rate on foreign debtI extraordinary negative weather shock (el Niño of 1982-1983)

policy responses:I cutting public investmentI arrears in debt paymentsI inflationary finance


Return to democracy

Belaunde’s second term 1980-1985hit by adverse shocks:

I drying out of foreign financeI worsening interest rate on foreign debtI extraordinary negative weather shock (el Niño of 1982-1983)

policy responses:I cutting public investmentI arrears in debt paymentsI inflationary finance


Heterodox Peru

The heterodox program of August 1985: “control and spend”

freezing of exchange ratefreezing of public sector prices: gasoline, electricity, water, etctemporary freeze of all pricestax exemptions to selected sectorsreduction of interest rate: zero interest rate for agricultural loansdebt default (debt service capped at 10 % of exports)

Peru declared ineligible by the IMFcommercial loans to Peru classified as “value-impaired” in the US


Heterodox Peru

The heterodox program of August 1985: “control and spend”freezing of exchange ratefreezing of public sector prices: gasoline, electricity, water, etctemporary freeze of all pricestax exemptions to selected sectorsreduction of interest rate: zero interest rate for agricultural loansdebt default (debt service capped at 10 % of exports)



Heterodox Peru

The heterodox program of August 1985: “control and spend”freezing of exchange ratefreezing of public sector prices: gasoline, electricity, water, etctemporary freeze of all pricestax exemptions to selected sectorsreduction of interest rate: zero interest rate for agricultural loansdebt default (debt service capped at 10 % of exports)



Heterodox Peru

initial successI inflation goes down and economic reactivationI similar to other macroeconomic populist episodes in

Dornbusch-Edwards (1991)

inflation rebounds in 1987, exchange rate lags, loomingbalance-of-payment crisislaw of nationalization of the banking sector (July 1987)

I passed by government and opposition in Congress, defended bycourts

I government backtracks after huge demonstrations (MVLL)I turning point

why persist in failed policies? gambling for success with modeluncertainty?


Heterodox Peru



inflation rebounds in 1987, exchange rate lags, loomingbalance-of-payment crisis

law of nationalization of the banking sector (July 1987)I passed by government and opposition in Congress, defended by

courtsI government backtracks after huge demonstrations (MVLL)I turning point



Heterodox Peru








Heterodox Peru








The unique exchange rate, and othersSept 1988: 33 → 250 intis per USD


Monthly inflation and hyperinflation episodesel Salinazo y el Fujishock

0

100

200

300

400

88−01 88−04 88−07 88−10 89−01 89−04 89−07 89−10 90−01 90−04 90−07 90−10 91−01months

Per

cent



Content

1 Overview

2 Growth accounting





7 Conclusions


Stabilization

in 1990 a political outsider, Fujimori, was elected presidenttwo camps in new administration:

I exchange-rate based versus monetary-based programI total lack of credibility of state policies made exchange-rate based

stabilization unviable

key aspects of the August 1990 stabilization plan:I initial devaluation (166%) and then an exchange rate target

(managed floating)I freeing regulated utility prices: gasoline (3040%), electricity

(5270%), water (1318%), etcI monetary anchorI reduction of banking reserve requirementsI fiscal austerity measuresI trade liberalizationI Creation of Budget Committee (coordination between Central Bank,

Finance Ministry and Revenue Authority)


Stabilization

in 1990 a political outsider, Fujimori, was elected presidenttwo camps in new administration:

I exchange-rate based versus monetary-based programI total lack of credibility of state policies made exchange-rate based

stabilization unviablekey aspects of the August 1990 stabilization plan:

I initial devaluation (166%) and then an exchange rate target(managed floating)

I freeing regulated utility prices: gasoline (3040%), electricity(5270%), water (1318%), etc

I monetary anchorI reduction of banking reserve requirementsI fiscal austerity measuresI trade liberalizationI Creation of Budget Committee (coordination between Central Bank,

Finance Ministry and Revenue Authority)


Stabilization and its aftermath

Two pillars of stabilization:1 strong commitment to cut inflationary finance

I after initial emergency loan, government committed not to ask forcentral bank financing

I new Central Bank Law (1993) rules out government financing bythe central bank

2 market-friendly policiesI eliminating multiple exchange rates, freeing exchange rateI reduction of tax and tariff dispersionI privatization of state-owned enterprises


Stabilization and its aftermath

Two pillars of stabilization:1 strong commitment to cut inflationary finance

I after initial emergency loan, government committed not to ask forcentral bank financing

I new Central Bank Law (1993) rules out government financing bythe central bank

2 market-friendly policiesI eliminating multiple exchange rates, freeing exchange rateI reduction of tax and tariff dispersionI privatization of state-owned enterprises


Monthly inflation during stabilizationArgentina, Ecuador and Peru

0

5

10

15

20

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58Months after stabilization

Per

cent

ArgentinaEcuadorPeru


Why did stabilization take so long?

1 uncertainty about commitment of Fujimori government to endfiscal dominance

I Fujimori campaigned against “orthodox shock” proposed by MVLLI conflicts with Congress→ “self coup” of 1992 and new constitution

of 1993I is authoritarian rule necessary for stabilization?

2 intertemporal budget constraint of the government was not clearuntil debt renegotiation

3 unclear monetary targets / lack of coordination between treasuryand central bank

4 vulnerability of stabilization due to persistence of dollarization5 lack of instruments to conduct independent monetary policy

I open market operations (Central bank certificates of deposits) tooka few years


























4 vulnerability of stabilization due to persistence of dollarization

5 lack of instruments to conduct independent monetary policyI open market operations (Central bank certificates of deposits) took

a few years











Why (and how) politicians led to different results after1990?

institutional changes: new law of central bank

public opinion giving the right incentives to politicians

signalling





signalling





signalling


Content

1 Overview

2 Growth accounting





7 Conclusions


Conclusions

demand driven policies?

two radical attempts to refashion the economy: 1968-1975 and1985-1987fundamental mistrust in market allocations by economic andpolitical actors in the run-up to hyperinflationcompounded by wishful thinking or wrong modelsocial learning after the trauma of great depression +hyperinflation + violence in the 1980s


Conclusions

demand driven policies?two radical attempts to refashion the economy: 1968-1975 and1985-1987fundamental mistrust in market allocations by economic andpolitical actors in the run-up to hyperinflationcompounded by wishful thinking or wrong model

social learning after the trauma of great depression +hyperinflation + violence in the 1980s


Conclusions

demand driven policies?two radical attempts to refashion the economy: 1968-1975 and1985-1987fundamental mistrust in market allocations by economic andpolitical actors in the run-up to hyperinflationcompounded by wishful thinking or wrong modelsocial learning after the trauma of great depression +hyperinflation + violence in the 1980s


Documents

Monetary and Fiscal History of Peru 1960-2017 · Monetary and Fiscal History of Peru 1960-2017 Radical Policy Experiments, Inﬂation and Estabilization César Martinelli1 Marco Vega2