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Currencies, Compensations, and Coalitions: The Politics of Exchange Rate Valuation in Argentina, 1963-2007. David Steinberg Northwestern University d-steinberg@northwestern.edu. The Puzzle. Undervalued exchange rates are beneficial Increase economic growth Prevent financial crisis

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Currencies, Compensations, and Coalitions: The Politics of Exchange Rate Valuation in Argentina, 1963-2007

David Steinberg

Northwestern University

d-steinberg@northwestern.edu

the puzzle
The Puzzle
  • Undervalued exchange rates are beneficial
    • Increase economic growth
    • Prevent financial crisis
  • Undervalued exchange rates are rare
    • Median exchange rate = 16% overvalued
  • Research Questions
    • Why is overvaluation so common?
    • When is undervaluation likely?
    • Classic Example of Overvaluation: Argentina
existing explanations of undervaluation
Existing Explanations of Undervaluation
  • Policymakers’ Ideas: Prefer Undervalue
    • Martinez de Hoz (1976-80)
    • Cavallo (1991-96)
  • Tradable Industries
    • Relatively powerfulin Argentina
    • Tradables often support overvaluation
typical policy options
Typical Policy Options
  • Uncompensated Undervaluation
    • Undervalued with nominal devalue and/or contractionary macro policy
  • Compensated Overvaluation
    • Overvalued with currency stability and high spending
theory why is overvaluation so common
Theory: Why is Overvaluation So Common?
  • Argument: Broad coalition supports compensated overvaluation
  • Nontradable Sectors
    • Benefit from overvaluation
  • Tradable Sectors:Benefits high spend & fixed ER > benefit undervalued
    • Small benefits undervaluation
    • Large benefit high spending
    • Large benefit currency stability
support for compensated overvaluation 1991 98
Support for Compensated Overvaluation: 1991-98
  • Context: Overvalued peg
  • Option I: Devaluation
  • Option II: Deflation
  • Option III: Compensation
    • Expansive Fiscal Policy
    • Targeted Compensations
theory when will er be undervalued
Theory: When will ER be Undervalued?

Argument: When undervaluation is compatible with pegs and high spending.

When Can Undervaluation be Compensated?

Idle Capacity: Macro policy has limited effect on price level

High Commodity Export Prices: Increase government revenues

Causal Logic

Econ Conds   cost undervaluation  political support undervaluation  undervalued currency

why undervalued exchange rates kirchner 2003 05
Why Undervalued Exchange Rates? Kirchner (2003-05)

Policies: “Compensated Undervaluation”

Undervaluation, peg and high spending

Impossible? Role of Economic Conditions

Idle Capacity: Spending not produce inflation

High Commodity Prices: Govt revenues from retenciones allow compensate without inflation

Multi-Sectoral Coalition:

Manufacturing: Undervaluation & high spending

Construction: “Pampered” by public works

real exchange rate appreciation 2006 08
Real Exchange Rate Appreciation (2006-08)
  • New Context in 2005: Full Capacity
  • Harder Choices
    • Increase Fiscal Surplus (Min Econ Lavagna)
    • Stay the course (Pres Kirchner)
      • Construction
      • Manufacturing
  • Effects of Compensated Undervaluation
    • Inflation > 20%
    • RER appreciation > 12%
summary conclusions
Summary & Conclusions

Why Undervaluation So Rare?

Policies required for undervaluation politically unpopular

1990s: Benefits Peg > Benefits Depreciation

2005-08: Benefits High Spend > Benefits Undervaluation

Political Logic of Overvaluation: Satisfies multi-sectoral political coalition

Nontradable Sectors: Benefit from overvaluation

Tradable Sectors: Benefit from compensatory policies