Currencies, Compensations, and Coalitions: The Politics of Exchange Rate Valuation in Argentina, David Steinberg Northwestern University

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 Policymakers’ Ideas: Prefer Undervalue –Martinez de Hoz ( ) –Cavallo ( ) Tradable Industries –Relatively powerful in Argentina –Tradables often support overvaluation

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? 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: Context: Overvalued peg Option I: Devaluation Option II: Deflation Option III: Compensation –Expansive Fiscal Policy –Targeted Compensations

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 ( ) 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 ( ) 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 Why Undervaluation So Rare? –Policies required for undervaluation politically unpopular –1990s: Benefits Peg > Benefits Depreciation – : 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