David Steinberg Northwestern University d-steinberg@northwestern

1. Currencies, Compensations, and Coalitions: The Politics of Exchange Rate Valuation in Argentina, 1963-2007 David Steinberg Northwestern University d-steinberg@northwestern.edu

2. 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

3. 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

4. Typical Policy Options • Uncompensated Undervaluation • Undervalued with nominal devalue and/or contractionary macro policy • Compensated Overvaluation • Overvalued with currency stability and high spending

5. 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

6. Support for Compensated Overvaluation: 1991-98 • Context: Overvalued peg • Option I: Devaluation • Option II: Deflation • Option III: Compensation • Expansive Fiscal Policy • Targeted Compensations

7. 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

8. 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

9. 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%

10. 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