Home Finance Latin America’s Inflationary Past Draws Lessons About Fiscal and Monetary Largesse in Advanced Economies

Latin America’s Inflationary Past Draws Lessons About Fiscal and Monetary Largesse in Advanced Economies

by internationalbanker

By Dalton Gardimam, Chief Economist, Ágora Investimentos (Bradesco)

 

 

 

 

Latin America’s (LA’s) vast experience with frequent and severe inflationary episodes has often been attributed to economic mismanagement (fiscal and monetary actions) and external shocks. That historical knowledge is useful given the colossal COVID-related fiscal and monetary responses in developed economies, notably the United States and Europe, with unprecedented and massive increases in deficits and debts. Latin America offers a rich understanding of the long-lasting consequences of fiscal and monetary largesse. The practical aspect is a necessary caution about today’s assumptions of a painless recovery (no recession) and a fast convergence to 2-percent inflation targets in the developed world. The inflation surge in 2020-21 is still unfinished business in advanced economies. Debt, as Latin America learned the hard way, is not “resolved” by the passage of time without a resolute will (in other words, fiscal consolidation). Debts tend to continue to pressure inflation for years to come. That is a key lesson for advanced economies from a glance at LA’s experience with debt levels and inflation rates.

When investors think inflation, especially in a historical context, the chances are high that while accessing their memories, they will recall Latin American countries as examples of painful inflationary experiences. In fact, high inflation in Latin America has been a recurring and challenging economic issue over the last five decades, differing in many ways from the rest of the world and always more acute in the region than elsewhere.

The immediate COVID-related inflation-rate surge and high-inflation environment over the last two years have been a global phenomenon. With the benefit of hindsight, in the COVID and post-COVID periods, LA’s inflation did not stand out as a bigger problem there than it was elsewhere (except in the cases of Venezuela and Argentina, which suffered from severe inflation well before the COVID outbreak). The surprises this time were the extraordinary inflation levels in the US and Europe. This pattern of higher developed-world inflation did not occur by chance but was a direct result of exceptional fiscal and monetary policies, at their “center” different from those of the past. Except for the rare and temporary example of 1970s inflation, exceptional inflation was an emerging-markets problem, with LA probably being the clearest and most dramatic example.

A simple comparison of inflation’s history in LA and the rest of the world reveals some clear patterns. Data is relatively sparse and difficult to compare in the 1960s, but Latin American inflation was relatively tame during that period. However, since the ‘70s, LA’s inflation has stood out as an outlier, with governments often resorting to deficit spending and outright money printing, laying the groundwork for even worse inflationary problems. Oil shocks (1973, 1979) magnified the challenges for the region tremendously.

Several hyperinflation episodes in Latin America

This process culminated in the 1980s with hyperinflation or near-hyperinflation in several Latin American countries, primarily due to debt crises and fiscal and monetary mismanagement. Political instability was both a cause and a consequence of unparalleled inflation. Using Philip D. Cagan’s simple but useful definition of hyperinflation (monthly inflation rates greater than 50 percent), Argentina reached this threshold in 1989-90, as did Bolivia (1984-85), Brazil (1989-90), Chile (1973) and Peru (1988)1. According to official (unreliable) data, Venezuela posted hyperinflationary marks all over the board from 2017 to 2020, with 2018 CPI (consumer price index) inflation deemed at 65.374 percent!

In the 1990s, many Latin American countries undertook economic-stabilization programs and implemented market-oriented reforms. These policies helped to control inflation and promote economic stability in the region, while in the 2000s, inflation rates remained relatively stable in most of LA (apart from Argentina and Venezuela).

Seasoned investors may remember that in the ‘70s, inflation also became a problem in the industrialized world. The average annual inflation rate in the US was 7.5 percent. This superlative annual figure compares to the highest monthly inflation rates in Peru (397 percent), Argentina (197 percent) and Brazil (82 percent). There is no doubt that the 7.5-percent US CPI was high (especially when compared to the 2.5-percent average of the ‘60s). Because of that inflation spike, the policy reaction was extremely aggressive in the Volcker (Federal Reserve Chairman Paul A. Volcker Jr.) days, with the federal funds rate set at 20 percent (March 1980).

The panoramic view of inflation in LA over the 1970s, the 1980s and part of the 1990s highlights the extraordinarily high inflation levels in that region. Inflation was a major economic problem practically everywhere in the region for more than three decades. We have focused on the US experience, but the generalization is true for most of the developed world: Inflation showed an exceptionally high pattern during the late ‘70s but was soon contained. Over the last 25 years or more, inflation had ceased to be a major economic problem in the developed world…until the pandemic.

Inflation is higher elsewhere, too.

Several Latin American countries have faced increased inflationary pressures in the 2020s, driven by COVID-19-related problems, but many developed economies have also experienced rising inflation during the 2020s. That is the new pattern: Inflation rates reached unthinkable levels not only in LA but in several developed countries with low and stable inflation histories. US CPI inflation peaked at 9.1 percent in June 2022. Although producer prices are more volatile and measure a different set of prices than CPIs, the peak level of Germany’s PPI (Producer Price Index) was flabbergasting: 45.9 percent in September 2022. Taking Brazil as a benchmark, its peak CPI was 12.1 percent. High? Yes, but in comparison, the euro area’s harmonized CPI reached 10.6 percent in October of last year. Surprising and unpleasant inflation levels are no longer an exclusive feature of LA but of somewhere else, too.

The exception became the norm (i.e., inflation is now widespread in LA). The bright exception (Germany and the Deutsche Bundesbank) became an unpleasant one. While LA was not in a position to post lower relative inflation rates, showing relatively similar figures revealed that the same problem was being experienced elsewhere. It is important to remember that large chunks of most Latin American countries’ exports are related to commodities, making them naturally more exposed to external shocks, with currency instabilities pressuring inflation rates further. The fact that Europe and the US posted the inflation rates seen in 2022 reveals the common root of the inflationary sources in LA decades ago: fiscal and monetary extravaganza.

Fiscal largesse in advanced economies

The International Monetary Fund (IMF) staff compiled an excellent database of fiscal responses to the COVID pandemic. On average, advanced economies spent 11.7 percent of their gross domestic products (GDPs) on fiscal resources (additional spending and forgone revenues) plus a similar amount in loan guarantees. This is colossal.

On average, emerging markets in the same dataset spent 5.7 percent of GDP, while loan guarantees stood at 4.2 percent. These numbers represent roughly half of what advanced economies expended, with loan guarantees accounting for slightly more than a third.

On the monetary front, at the end of 2021, real rates (basic rate deflated by YoY [year-over-year] CPI inflation) were -6.4 percent in the US and -4.8 percent in the euro area. Monetary aggregates (M2) in the US moved up US$6.5 trillion from March 2020 ($15.3 trillion) to March 2022 ($21.8 trillion). The Federal Reserve’s (the Fed’s) assets shot up $1.4 trillion in 2008 during the most severe global crisis since the Great Depression. But in 2020, the Fed’s assets increased by $4.91 trillion to $8.97 trillion!

In summary, the fiscal and monetary responses to the pandemic in advanced economies had no parallel, were extremely aggressive, concentrated timewise and widespread. In 2020 and 2021, the public debate focused on the appropriate allocations of resources and the moral-hazard aspects of extreme-distribution schemes. Over time, and probably for several years, the impacts of debt accumulation will supersede everything else. The massive stimulus packages and financial-support measures introduced by developed countries have resulted in substantial increases in government debt with relevant long-term economic consequences, potentially leading to higher taxes and/or reduced government services in the future.

On this last point, the fiscal largesse in Latin America in the ‘70s and ‘80s was followed by extreme deteriorations in public services in the following decades. Too much debt in various LA economies played a massive negative role for years and still weighs heavily on many jurisdictions in the region.

Conclusions

Latin America has had a history of frequent and severe inflationary episodes compared to the rest of the world over the past five decades, often attributed to economic mismanagement (chiefly fiscal and monetary) and external shocks. Political instability before and after fueled the process. It is fair to say that most Latin American countries have made significant progress in controlling inflation, while the region still faces challenges, especially in troubled countries such as Argentina and Venezuela. Given this historical background, COVID-related fiscal and monetary responses in developed economies—notably the US and Europe, with unprecedented and massive increases in deficits and debts—will take years or even decades to be metabolized. Our views and experiences in LA induce us to be cautious regarding the evolution of a painless recovery (no recession) and a fast convergence to 2-percent inflation targets. The resolution of the inflation surge that began in 2020-21 is still unfinished business in advanced economies. Debt, as Latin America learned the hard way, is not resolved by the passage of time. Without a resolute will (i.e., fiscal consolidation), debts will continue to pressure inflation for years to come. That is a key lesson from a glance at the Latin American experience with debt and inflation.

 

Reference

1 Cato Institute: “World Hyperinflations,” Steve H. Hanke and Nicholas Krus, August 15, 2012, Working Paper Number 8.

 

 

ABOUT THE AUTHOR
Dalton Gardimam is the Chief Economist of Ágora Investimentos (Bradesco BBI). With 29 years of experience in the Latin American financial market, he previously served as the Chief Economist at Deutsche Bank in Brazil, Crédit Agricole, Crédit Lyonnais and Crédit Lyonnais Securities Asia. He has also worked as a Senior Economist in the economic area at Unibanco. Dalton has a B.A. in Economics from University of São Paulo and a M.Sc. from Fundação Getulio Vargas.

 

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