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Latin America's Economy: Diversity, Trends, And LATIN AMERICA'S ECONOMY: Chapter 6 DIVERSITY, TRENDS, AND CONFLICTS INFLATION Latin America has a longstanding reputation for its battles with runaway inflation. The most notorious example is Bolivia's recent Eliana Cardoso hyperinflation. Betweeri May and August 1985, Bolivian inflation Ann Helwege reached an annualized rate of 60,000 percent, the seventh worst c~se of hyperinflation in world history. Shopkeepers found themkelves rushing into the street to exchange pesos for dollars as soon aJ they made a sale; to wait even an hour could mean a noticeable loss. Although none of Bolivia's neighbors has managed to match this experience, three-digit inflation rates are a recurrent problem in the region. The cost of very high inflation in terms of economic growth is substantial. Uncertainty about prices brings about short horizons for production decisions and concentration of assets in inflation hedg­ ing.The-economic structure that re8ults emphasizes finance at the expense of production. Hoarding and speculation displace real pro­ duction. As one Nicaraguan described the response to the 30,000 · percent inflation rate in his country in 1988; "It's a hussle economy. Everyone is out to beat the market and no one is producing any­ thing." Capital flight also rises with inflation. The World Bank estimates that capital flight from Argentina between 197 4 and 1982 amounted to 72 percent of the country's external debt, implying that if the Argentine government were able to restore confidence in the local currency, most of its foreign exchange crisis would be resolved. Although the extreme cases of inflation in Latin America have caught world attention, inflation rates in Latin America have dif­ fered widely over time and among countries. On the whole, inflation The MIT Press Cambridge, Massachusetts London, England 141 Inflation 0 Chapter 6 rates have increased markedly during the 1980s. Table 6.1 divides the Latin American countries (except Cuba and Nicaragua) into 1986-1989 three groups. During the twenty-five years between 1960 and 1985, 1960-1969 1970-1979 the high inflation countries experienced average inflation rates of High inflation countries 1,392.l more than 30 percent per year. All the countries in this group are 132.8 335.5 Argentina 22.9 2,251.5 28.7 found below the equator. The low inflation countries had average 6.3 15.9 Bolivia 142.0 795.6 inflation rates below 10 percent during the 1960-1985 period. 45.8 30.5 Brazil 23.8 18.3 Almost all countries in this group are situated in Central America. 25.l 174.0 After 1985, Bolivia and Chile !which used to be among the most Chile 97.3 1,169.2 9.8 26.5 inflationary economies in Latin America) brought inflation under Peru 48.9 73.0 50.l 59.3 control, in contrast with most other countries in the region, where Uruguay Weighted 224.0 844.8 inflation increased further. Figure 6.1 shows the decline of inflation 36.6 53.7 in Chile, and figure 6.2 shows how Mexican inflation rates, which average• '1 historically were very low, increased in the 1980s. Table 6.2 shows Middle inflation countries 24.S 19.3 23.l ,, the annual inflation rates in countries subject to acute inflation Colombia 11.2 16.8 10.4 34.2 acceleration after 1985. Costa Rica . 2.0 49.9 11.9 25.6 One single model could hardly explain the .behavior of inflation Ecuador 4.2 84.1 in all these countries. This chapter looks at different theories and 14.7 56.4 Mexico 2.7 25.4 describes various experiences with inflation in Latin America. The · 11.l 17.0 Paraguay 4.3 first section reviews the longstanding debate between monetarists 63.5 and structuralists about the causes of inflation. Over time both Weighted 15.3 45.1 average• 4.7. schools have evolved but neither has yet to offer a complete diag­ nosis of inflation. Consequently, prescriptions for reducing inflation · Low inflation countries 32.6 invariably fail at the combined task of achieving price stability and I Dominican 9.2 16.9 Republic 1.3 22.9 growth. 9.4 15.2 Further progress in explaining inflation depends on integrating El Salvador 0.4 16.7 8.9 8.2 the insights offered by conflicting points of view. In the second Guatemala 0.5 0.9 9.2 10.6 section of this chapter, we address five concepts central to under­ Haiti 2.2 6.0 6.6 8.8 standin~ inflation: seigniorage models, foreign exchange crises, Honduras 1.9 0.4 6.0 5.0 dollarization, capacity constraints, and indexation. Panama 1.0 42.3 6.6 12.9 Venezuela 1.1 >NETARISM VERSUS STRUCTURALISM 24.0 Weighted 7.9 11.9 verage• · · 1.l In the 1950s and 1960s, two schools of thought, monetarism and structuralism, dominated the analysis of Latin American inflation. Monetarists argued that the main cause of inflation was deficit spending financed by money creation. Structuralists argued that inflation had its roots in real shortages of key goods in the economy and struggles between different groups in society to increase their i2 Chapter 6 Inflation 143 % over month of previous year 800,.-----.................................................-...; .............. _.:... ............................ ___, Table 6.2 Inflation rates, selected <;ountries, 1985-1990 700 (percentage per year, :Pecember-December) 1985 1986 1987 1988 1989 1990- 600 Argentina 385 82 175 388 4,924 1,833 500 Brazil 228 58 366 993 1,765 2,360 ~ Ecuador 24 27. 33 86 54 48 ~ 400 a. Mexico 64 106 159 52 20 30 300 Nicaragua 334 747 1,347 33,603 1,690 8,500 200 Peru 158 63 115 1,723 2,777 8,292 Uruguay 83 76 57 69 89 130 100 Venezuela 6 12 40 36 81 32 o±_.:.--r..__-.---..;:__..:;:::::::..o:::::;;::::::::::;:.:::::=;:::::::::;:::::::::::J a. Preliminary. 1973 1975 1977 1979 1981 1983 1985 1987 1989 Source: ECLAC, Preliminary Overview of the Economy of Latin America and the Figure 6.1 Caribbean (N:ew York: ECLAC, 1991}. · Inflation rate, Chile, 1973-1990. Source: .IMF, International Financial Statistics !Washington, D. C.:. International Monetary Fund, various issues). shares of national income. The debate focused not only on the theoretical causes of inflation but its appropriate solutions, which invariably involve political consequences. According to the mon­ % over month of previous year etarist view, to stop inflation, deficits must be cut and free enterprise 180,.------------~-----------...:...................... -s- .......---. encouraged. In general, structuralists are more inclined toward 160 government intervention in the economy to overcome supply con­ 140 straints. In recent years, structuralism has also put more emphasis on the inertial forces that sustain inflation. 120 c ~ 100 Monetarism a.QI 80 Monetarism explains inflation as the result of too much money 60 chasing too few goods. The most common explanation for sustained 40 money growth is the fin;mcing of budget deficits by money creation. Inflation is a monetary phenomenon in the sense that it could not 20 persist without sustained money growth. Table 6.3 and figures 6.3 O-r-'r""'......,.....,.-r-r--r-..,.-'r""'r-r.....,.-r-r--r--r-T"'""'1r--r-....-I and 6.4 illustrate this by showing a striking positive correlation 1m1m1~1m1m1~1•1~1~1~1~ between inflation and money growth in Latin America. 1 The obser­ Figure 6.2 vation that sustained inflation is always accompanied by monetary Inflation rate, Mexico, 1970-1990. expansion is the basis for the hypothesis that monetary expansion Source: . IMF International Financial Statistics (Washington, D. C.: · causes inflation. This leaves open the question of what' determines Internat10nal Monetary Fund, various issues). money growth {discussed later in this chapter). Monetarists see Chapter 6 Inflation 145 Table6.3 Average inflation and money growth, Latin American countries, 1965- 6011' 1985 (percentage per year) l'ii 500- Bolivia Inflation rate Money growth rate ~.... a.<ll 528.1 360.2 c 400· Argentina 137.3 120.9 (I)~ Chile '82.1 97.7 a. 300 en Brazil 62.1 63.8 iii a: 200 Uruguay 53.4 51.5 c: .Q Argentina Peru 36.4 38.5 ~ 100 Braz1Phile Uruguay Mexico 19.7 22.6 Peru Colombia 17.1 20.8 O-t--~-.-~~•. ~-r-~-.-~-.....---.,.----.~--.~-1 20 60 100 140 180 220 260 300 340 380 Costa Rica 12.4 18.6 . Money Growth, Percent Per Year Ecuador 12.1 19.0 Annual Average, Period: 1965-1985 Paraguay 9.8 15.4 Figure 6.3 ,,. .. Dominican Republic 7.9 10.3 Inflation and money growth in high-inflation countries, 1965-19~5. El Salvador 7.3 9.2 Source: IMF, International Financial Statistics (Washington, D. C.: Haiti 6.8 11.3 International Monetary Fund, various issues). Venezuela 5.9 13.2 5.5 9.5 Guatemala 22 Honduras 5.3 10.3 20 Panama 3.9 9.1 a Me xi -~ 18 Source: IMF, International Financial Statistics. .... Colombia a.II> 16 c 14 ~ 12 Costa Rica government deficits as the cause of the problem; structuralists see a.II> Ecuador a) 10 deficit spending and money creation as a· necessary response to Paraguay 8! 8 Dominican Rep. inflation caused by bottlenecks in the economy. c: El Salvador Haiti 0 6 Guatema1aVenezuela If government expenditures exceed tax collections, the govern­ ii Honauras ment must finance its deficit by borrowing or by printing money. s 4 Panama The financing of the government budget deficit can be written as: 2 0 Budget deficit = sales of bonds + external borrowing 4 6 8 10 12 14 16 18 20 22 24 + increase in money base. Money Growth, Percent Per Year Annua1Average,Period:1965-1985 There are two possible links between the budget deficit and money growth.
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