From bad to worse

ARGENTINA - Report 19 Mar 2020 by Domingo Cavallo

President Alberto Fernández says that now the problem is the economy, rather than the deficit -- meaning that the government will shift to prioritizing the preservation of income of workers and low-income families, and will try to contain the recession.His aim is no different from that of U.S. President DonaldTrump, who has also announced a $1 trillion (5% of GDP) fiscal package.

So far Fernández has announced a 700 billion peso (around $10 billion, or 2% of GDP) package, with destinies similar to those in the United States, focusing primarily on formal-economy employers and employees. Fernández will very likely have to expand the government package, to assure some income to the self-employed, and to workers in the informal economy. So it’snot unlikely that the increase in government spending will end up at 4% of GDP.

Officials and some independent economists argue that the Argentine measures may have the same effect as those being adopted in the United States. That may be true in terms of the effects on the level of economic activity and employment. But the impacts on inflation and currency devaluation may be verydifferent, since Argentina lacks access to credit, or a credible currency -- something that cannot be said about either Germany or the United States.

We estimate that tax revenue will drop significantly, probably by 1% of GDP. So, with an estimated increase in government expenditure on the order of 4% of GDP, the primary fiscal deficit may very well rise from 1% of GDP in 2019 to 6% in 2020.

The monetary base is right now around 1,900 billion pesos, or 6% of GDP. To finance a fiscal deficit of 6% of GDP, the Central Bank will have to double the monetary base. In addition, it will have to pay for the eventual dollar surplus in the official exchange market, and interest on the LELIQs.

Even if the government uses price controls and every imaginable method of trying to prevent price increases, it is unlikely that inflation will be much below 100% for 2020. The scenario is not very different from that of the mid-1970’s, when major fiscal and monetary disequilibria produced stagflationary plus hyperinflationary effects that lasted until 1990. To prevent a similar outcome, the government must prepare for complete reorganization of the economy, to begin the day after the announcement that the coronavirus crisis has been defeated. Such a plan will need as a pillar a monetary and financial reform, the ability to recreate a stable currency, and to recover credit.

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