The Argentine economic crisis.

• Author: Murphy, Ricardo Lopez

The Argentine economy suffered a deep crisis during 2001 and 2002. Poverty stretched to one in every three homesteads in the suburbs of Buenos Aires, and the traumatic departure from convertibility, together with financial crisis and default (public debt default), undermined investor confidence, both local and foreign.

Causes of the Crisis

We believe the crisis owed its existence to four main causes: (1) inappropriate fiscal policy, (2) wage and price rigidities inconsistent with a fixed exchange regime, (3) a considerable, adverse external shock, and (4) political turmoil.

Two-Tiered Fiscal Inconsistency

On one side, public expenditure growth measured in U.S. dollars outpaced GDP growth, corrected by tradable-goods prices. On the other, the federal and provincial primary fiscal surplus did not rise at an equal pace with the hike in the financial burden linked to growing debt and the gradual phasing out of preferential-rate bonds (Brady bonds and others issued to cancel government liabilities with pensioners and state contractors) replaced in turn by market-rate notes.

The impact and stress on convertibility caused by real shocks has led many analysts to challenge the fiscal nature of the crisis. (1) In our opinion, that doubt stems from an incomplete observation of Argentine data and to a misinterpretation of causality between public expenditure and real exchange rates.

A first dimension of the issue bears on the fact that public expenditure relies heavily on nontradable goods and services. An uncontrolled expansion of the nontradables sector leads to real exchangerate overvaluation in small, open economies because the pressure exerted on domestic prices cannot be offset by tradable-good prices limited by a fixed exchange rate and foreign prices. Throughout the 1991-2001 period, the three levels of government expenditure rose 77 percent in dollar terms, while the Argentine GDP rose 57 percent and dollar-denominated tradable prices fell (Table 1).

Even worse, government data do not adequately gauge state outlays because deficit registers systematically underestimate public debt variation--that is, the official data do not consider as "expenditure" the issue of new government debt to cancel claims on the government. If expenditure is "corrected" yearly to account for the difference between consolidated deficits and debt variation, public expenditure in the 1991-2001 period grew about 97 percent; in dollar terms that figure is more than 40 percentage points above tradable-price-adjusted GDP growth. A clearly expansive public spending policy, financed largely by borrowing abroad...