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 powerful in 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