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Alejandro Hernandez -Delgado, Felipe Meza, and Ignacio Trigueros- Legarreta (ITAM) April 2014

Three Stages of Mexico´s Monetary and Fiscal History : Growth with Low Inflation , Fiscal Expansion and Reforms. Alejandro Hernandez -Delgado, Felipe Meza, and Ignacio Trigueros- Legarreta (ITAM) April 2014 Discussant : Gerardo della Paolera (Universidad de San Andrés) .

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Alejandro Hernandez -Delgado, Felipe Meza, and Ignacio Trigueros- Legarreta (ITAM) April 2014

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  1. ThreeStages of Mexico´sMonetary and Fiscal History: GrowthwithLowInflation, Fiscal Expansion and Reforms Alejandro Hernandez-Delgado, Felipe Meza, and Ignacio Trigueros-Legarreta (ITAM) April 2014 Discussant: Gerardo dellaPaolera (Universidad de San Andrés)

  2. ThreeStages of Mexico´sMonetary and Fiscal History: GrowthwithLowInflation, Fiscal Expansion, and Reforms • Analysis of the monetary and fiscal history of Mexico (circa 1978-2009) through the lenses of Sargent (1992), Kareken and Wallace(1981), Nicolini( 2010) . • The authors follow the economics of budget constraints which includes debt denominated in foreign currency and debt indexed to inflation. • This is expressed as in Kehoe, Nicolini, Sargent (2013) as:

  3. TheEconomics of BudgetConstraints • Rearranging the «canonical» budget constraint, KNS(2013) obtain equation (1a): • The debt triplets are to be explained by the inflation tax, the return on nominal bonds, the return on the indexed bonds, the return on the dollar denominated debt and the primary deficit including transfers.

  4. TheEconomics of BudgetConstraints defining: • Theauthorsgather data forthe 1978-2009 period to decomposethechanges in publicdebtinto (a) theinflationtax; thereturnonthegovernmentdebt and theprimarydeficit.

  5. Definitions and Data • Government: PublicSector + IFDC +IFIBC • Data: InitialProblems to assesstheDebt Stock: mix of registration at par and marketvalues. ProxiedforNationalDebt • OnlyPublic Sector, usedmarketvalue of debtissuedbynationalgovernment net of debts at Central Bank

  6. Computing theForeignDebt Ratio • No statisticsonthemarketvalue of foreigndebt: the 1988 debt stock estimated at 64 billion USD composedbythebankdebt at marketvalues plus non-bankdebt at facevalue. • Thentocalculatetheyearly stocks use of theflowsrelatedtoassets and liabilitiesfromthe Capital account.

  7. DifficultiestogetindexedDebt • In thepaper, onlya consolidated figure forthe Total Nominal debtcouldbeobtained. The ratioθrisimplicitlyincluded in theNationalDebt Ratio θN.

  8. Fig. 1: Evolution of Nominal, ForeignDebt Ratios, and Deficit

  9. Fig. 2(a): Change in Nominal Debt Ratio and Deficit(fraction of GDP)

  10. Fig. 2(b): Change in ForeignDebt Ratio and Deficit(as fraction of GDP)

  11. Fig. 2(c): Change in Monetary Base to GDP and InflationTaxRevenue (as fractions of GDP)

  12. Fig. 2(d): Change in ForeignDebt Ratio and Total Net InterestPayments (as fractions of GDP)

  13. Results • In Figure 1 (and 6), primary deficits until 1982/3. After 1986 fall in the foreign debt ratio but increase in the nominal debt ratio. • In 2(a) through 2(d), the graphs show if the deficit, total interest payments and the inflation tax revenues drive changes in both ratios. • In 2(b) the ratio of foreign debt seem to respond strongly to changes in primary deficit; in 2(d) total net interest payments is closely related to the increase in the Foreign Debt ratio.

  14. Fig. 6: PrimaryDeficit as a Fraction of GDP

  15. Accountingfor total net interestpayments • After calculating the sequences of the debt ratios, the authors compute net interest on the debt: and • They need to proxy the gross interest rate R and r*: for R the proxy is the yield on the CETE, the interest payments is calculated as a residual from the total. • In Figure 4, the interest rate payments on foreign debt is the main source of fluctuations in total interest payments.

  16. Fig. 4: Total Net Paymentson Nominal Debt; OnForeignDebt and Total Net InterestPayments

  17. Fig. 3: Growth Factor of Price Level and Gross Nominal YieldonDomesticDebt

  18. Analysis of cumulativechanges in debt and theirdrivingcomponents

  19. Analysis of cumulativechanges in debt and theirdrivingcomponents • Introduce: • A sequence of primary (deficits) surpluses; • A sequence of interest payments; • The negative of cumulative changes in the money base (reduces borrowing); • The negative in cumulative changes in the inflation tax. • Results: In 5(a) interest rate payments are the main driving force to increase the level of indebtedness. In 5(b), the surpluses after 1983 the main force to reduce the ratios.

  20. Fig. 5(a): CumulativeChange of Nominal, Foreign and Total Debt Ratios

  21. Fig. 5(b): Cumulativechange of Debt Ratios, CumulativePrimaryDeficit, and Negative of CumulativeInflationTaxRevenue

  22. Fiscal Expansion of 1970s and the Debt Crisis of 1982 • Dynamics lead by sizeable primary deficits (Fig 6); jump in 1981. • Banco de Mexico dominated by the government (fiscal dominance). • Progressive increase in the level of indebtedness until 1982 (Fig 9), when debt constrained , inflationary scenario. • The stylized facts are explained by the SW model: deficits need not be inflationary as long as you can finance them by issuing debt (foreign?), once debt intolerance is present, the Unpleasant “Fiscal” Arithmetics push you to an inflationary scenario. • The “repressed” inflation is a short-run equilibrium when running continuous primary deficits.

  23. Fig. 6: PrimaryDeficit as a Fraction of GDP

  24. Fig. 9: Total Debt as a fraction of GDP

  25. Fig. 7: InflationTaxRevenue as a Fraction of GDP

  26. Fig. 8: InflationRatemeasuredwiththe GDP Deflator (%)

  27. Economic Reforms in the 1990s and the 1994 Crisis • In 1990’s Independence of the Banco de Mexico, goal is to maintain the purchasing power of the peso: limits advances to the Government (Change in Macroeconomic Regime?) • However, huge internal political shock in March 1994, Colosio killed. Political Uncertainty; start issues of Tesobonos; sizeable capital outflows by Nov/Dec 1994. • Change in the exchange rate regime. • Sudden Stop? Substituting for short term borrowing ( with maturities shortening) and the ratio dollar indexed debt to international reserves increasing) but even then in early 1995 Mexico could not roll-over the short term debt. • How the facts fit with the model?

  28. Economic Reforms in the 1990s and the 1994 Crisis • Some stylized facts: • Debt ratios not at its maximum, however stock of tesobonos net of international reserves equivalent to 30billion USD. • Interest rates skyrocketed because the expectations of further devaluations increased and because of tight monetary policy which maybe the agents believed was to become unsustainable (role of the external bail-out to redress those expectations?) due to a potentially explosive burden of the short-term debt. (here there is a SW flavor only that maybe bailout meant degrees of freedom to maintain monetary independence) • These dynamics in spite of a contractionary monetary policy and a pro-cyclical fiscal policy. Smax was not attained because of bail-out?

  29. Fig. 10: International Reserves and Government Bonds (in millions)

  30. Fig. 11: Averagemonthlyannualized nominal interestratepaidby 28 days CETES (%)

  31. A HistoricalExample of DeficitDominance: Debt, Fiscal Deficits and Inflation (Argentina 1885-1893)

  32. Fig. 9: Total Debt as a fraction of GDP

  33. PrimaryDeficit Pre-Baring Crisis

  34. Fig. 6: PrimaryDeficit as a Fraction of GDP

  35. Price Level and Exchange Rate 84-1914

  36. Fig. 8: InflationRatemeasuredwiththe GDP Deflator (%)

  37. SustainedPrimaryDeficits: FromDebtFinanceto Fiscal Dominance “The monetary and fiscal inconsistency became apparent by the end of the year 1889. The government, already under a debt-ceiling constraint and with its specie reserves almost depleted, had no choice but to switch from debt finance to money creation to cover an ongoing budget deficit. For the 1889- 91 period, the accumulated inflation rate (163.7 percent) and the accumulated depreciation rate (152.7 percent) are closely correlated with the accumulated counterfactual inflation rate (154.9 percent)”.

  38. SustainedPrimaryDeficits: FromDebtFinanceto Fiscal Dominance “Before the curtain fell in 1891, the drama concluded with an economic policy that had finally exhausted all the available genuine means of finance and heavily relied on the inflation tax to finance the budget. The inflation tax and currency substitution interacted in unfortunate ways that exacerbated the fiscal problem. If there is a high sensitivity of velocity to inflation (a greater propensity for currency substitution) then this will imply a higher inflation rate for the same level of deficit, all else equal. Moreover, currency substitution will lower the base for the inflation tax, requiring an even higher inflation rate to sustain the same fiscal gap.» l6

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