MMT exacerbates and fails to control inflation-Latin America Populist episodes prove

In this section I analyze three of Latin America’s best known populist episodes: Chile during Salvador Allende’s socialist experiment from 1970 through 1973, Peru during the first Alan García administration (1985–90), and Venezuela during the Hugo Chávez and Nicolás Maduro governments (1998–present). Although each of these cases is unique, the three of them share the populist pattern discussed above, and followed policies similar to those espoused by MMT. Also, the three of them ended up in major crises. The case of Chile is possibly the most dramatic one, as the experiment with populist‐​socialist policies of President Salvador Allende ended up in a violent coup that was followed by a 17‐​year dictatorship. In Chile, inflation exceeded 500 percent in 1973. In both Peru and Venezuela, the central bank–financed fiscal expansions ended up in hyperinflation. In Peru the rate of inflation peaked at almost 8,000 percent, and the International Monetary Fund has forecasted that inflation in Venezuela will be almost 1 million percent by the end of 2019.18 The three countries studied in this section had a sovereign currency, and thus could (and did) follow the type of policies recommended by MMT economists. In addition, in all cases the exchange rate was not strictly fixed; the price of foreign currency was adjusted frequently (in some cases daily) through a crawling rate regime or a “dirty float” system.19 In every one of the episodes, exchange controls of one type or another were eventually put in place in an effort to slow down currency depreciation (Edwards 2010). I begin the discussion by presenting data on economic growth. I then discuss the expansion of public sector expenditures financed by central bank money creation, and the resulting inflation outbursts. The section ends with an analysis of the evolution of social conditions. I show that in the three cases, when the populist regime was replaced, real wages were lower than when the populist leader took over. Growth and Populism Phases In Figures 1–3, I present data on GDP growth for the three episodes. There are two dashed vertical lines in these graphs. The first one corresponds to the initial year of the populist episode; the second one refers to the first year of the post‐​populist regime. The similarities across cases are quite remarkable; the different phases of populist experiments are easy to detect in each one of these figures. • In the three episodes it is possible to see that the initial conditions are characterized by either very low or negative growth. As noted, these depressed circumstances give the populist leader the opportunity to present his/​her nationalistic, anti‐​globalization and anti‐​elite program, and to get to power. In Chile, growth in 1970 was 2 percent, which meant that per capita growth was slightly negative.20 In Peru, there was an IMF program at the time Alan García was inaugurated. Economic conditions were also negatively affected by the El Niño climatic phenomenon, which resulted in some of the worst flooding in the country’s history.21 In Venezuela, growth was negative the year Chávez won the elections. Depressed initial conditions in Venezuela were the result of a succession of failed adjustment programs — some supported by the IMF — and a decline in the price of oil. Memories of the repression and deaths during the Caracazo demonstrations and riots also contributed to the support of Hugo Chávez and his program (Edwards 2010). • As may be seen from these figures, Phase 1, with its booming growth, follows the launching of the populist programs. In Chile the economy grew at an impressive 9 percent during the first year of President Salvador Allende’s Unidad Popular government. Peru saw its GDP growth jump to 12 percent in 1986, one year after Alan García’s election. In Venezuela there was also important GDP recovery after the accession to power of the new leader. In Venezuela it is possible to detect the negative effect of the global financial crisis of 2008-09. However, there is a recovery, and the good times continued for a few additional years. In Venezuela, the positive‐​growth phase (Phase 1) was rather longer than usual. This was thanks to very positive terms of trade; the prices of oil and soybeans were very high during the early years of this episode (Edwards 2019). • Eventually, in every one of the three countries, the day of reckoning arrives, and Phase 3, with the collapse in growth, becomes a reality. As may be seen, in Chile there was negative growth in 1972, the second year of the Allende administration. In Peru growth was negative 9 percent in 1989, toward the end of the Alan García presidency. In Venezuela the economy collapsed in 2014. During Phase 4 the new postpopulist government had to put in place policies aimed at reducing inflation and reigniting growth. Monetary Policy, Fiscal Imbalances, and Inflation As noted, in all of these episodes there were massive fiscal expansions financed by money creation by the central bank. In Chile, the Unidad Popular government also nationalized the banking sector, as a way to facilitate the flow of credit to newly nationalized companies and major public infrastructure projects. In Peru, President Alan García tried to follow Allende’s footsteps and nationalize the banking and financial sectors. However, there was a massive popular opposition, and, after weeks of protests led by novelist and future Nobel Prize winner Mario Vargas Llosa, the government gave up on the attempt (Larraín and Meller 1991; Edwards and Edwards 1991). In Venezuela, the central bank came under significant political pressure, and in the early years of the Chávez administration its degree of independence was greatly reduced. During the populist experiment, the central bank’s main goal was to help the government achieve its political and social development goals (Carrière‐​Swallow et. al. 2016). In Tables 2 through 4, I present data on a number of key macroeconomic variables: public sector balance as percentage of GDP, rate of growth of the monetary base, annual inflation rate, current account balance over GDP, and real GDP growth. In addition to the boom and bust dynamics of growth already discussed, several results stand out from these tables. Fiscal Expansion. In all cases the fiscal deficit becomes very large during the episode. In two of the cases (Chile and Peru), a large imbalance develops immediately after the populist leader takes over. In Venezuela, it takes some time for the deficits to explode, but eventually it does happen. This delay is due to the extraordinarily high export prices during the early years of this experiment (Edwards 2019). In the case of Chile, I present two series for fiscal balance. The first one refers to the central government accounts, and shows that in 1973, the last year of the Allende administration, the deficit was almost 25 percent of GDP. The next column presents data for the “consolidated public sector” for 1970–73, and includes state‐​owned enterprises. As may be seen, in 1973 this measure of the deficit reached an astonishing 30 percent of GDP. In Peru, in 1983, two years before Alan García got to power, there was a huge deficit: 11.6 percent of GDP (Table 3). In 1984, President Fernando Belaúnde decided to call in the IMF, and an orthodox stabilization program was put in place. The data in Table 3 show that between 1983 and 1985 there was a draconian fiscal adjustment that amounted to 8 percent of GDP. This drastic fiscal correction generated a substantial jump in unemployment and a precipitous decline in real wages — 39 percent between 1982 and 1985 — and paved the way to Alan García’s electoral success in 1985. One of the first measures taken by García was to suspend the IMF program and to go back to very expansive fiscal policies. As may be seen in Table 3, in Peru the deficit exceeded 10 percent of GDP in 1987, 1988, and 1989. In 1990 it was slightly down to 8 percent of GDP. Throughout these years it was mostly financed by money creation by the central bank (Martinelli and Vega 2018). The picture for Venezuela, in Table 4, shows that during the early years of the Chávez administration the public sector ran a surplus. With the exceptions of 1998 and 2001, and thanks to a very high international price of oil, the early years of the Bolivarian Revolution were characterized by (relatively) balanced public‐​sector finances. However, the fiscal deficit surpassed the 3 percent of GDP mark in 2008, and from that point onward increased markedly every year, reaching a remarkable 31 percent of GDP in 2017. The initial fiscal imbalance in 2008-10 coincided with a sharp decline in oil prices in the global marketplace. However, when oil prices recovered in 2011, Venezuela made no attempt to adjust public finances. The decision was made to finance the deficit with money created by the central bank. In 2017 the deficit reached almost 32 percent of GDP, even higher than the consolidated fiscal deficits for Chile in the last year of the Allende administration. Money Supply Growth. The data in these tables show a clear connection between the eruption of very large fiscal deficits and a jump in the rate of growth of the money supply. This, of course, reflects the fact that in every one of these cases the central bank financed the expansion of public expenditures through the purchase of government debt. This was a deliberate component of these populist economic programs. This is illustrated by the following quote from García (1972: 102, 104), one of the economists behind President Salvador Allende’s economic program in Chile: “[The policy] was based on the simultaneous control of prices, wage increases, and increase in the public sector deficit… . [M]onetary and credit policy provided the financing for fiscal expansion and the deficit.“22 In Venezuela, the chairman of the Finance Committee of the National Assembly declared in 2010 that the central bank’s role was to finance the government. “It should support the development and social program approved [by the government]” (America Economía 2010). It is precisely this close relationship between fiscal deficits and money creation that makes these episodes particularly germane to the debate on the merits and prospects of MMT. Inflation. The data in these tables show that inflation was, eventually, extremely high in the four episodes. In Chile it surpassed 500 percent in 1973; in Peru, it reached hyperinflation levels — it exceeded 7,000 percent in 1990 — and in Venezuela it surpassed 130,000 percent in 2018. The IMF expects inflation in Venezuela to reach the 1,000,000 percent annual mark in 2019. As noted earlier, very high inflation feeds back into the fiscal deficit through the Tanzi‐​Olivera effect. When inflation is very high, indexation tends to become generalized, and wages are adjusted at increasingly shorter intervals. This means that the government wage bill — which in all of these countries was very substantial — increased rapidly, while taxes were assessed and paid based on lagged (and much lower) prices. In all of these cases a collapse in the demand for domestic money (or an increase in velocity) contributed significantly to the explosion of inflation. In Chile, for example, velocity in 1973, at the end of the Allende government, was 24 “times” per year, which was two times higher than the historical pre‐​Allende average of 12 times.23 Interestingly, during the last decade, velocity in Chile has been around 3 times. One of the most serious weaknesses of MMT is that it ignores the role played by the demand for money in macroeconomic outcomes. Economists have known for a long time that, as Patinkin (1965) masterfully emphasized, what matters is the excess supply (demand) in different markets. In his MMT Primer, Wray (2015: 254) declares that he is surprised by the notion that during a hyperinflation economic agents reduce their holdings of domestic money to a minimum. The absence of a prominent role for the demand for money (and changes in velocity) in the theoretical construct of MMT is, indeed, surprising. In Chapter 13 of the General Theory, Keynes explains that people hold money for three motives: transactions‐​motive, precautionary‐​motive, and speculative‐​motives (Keynes 1936: 168). He further argues that the demand for money (or liquidity preference) is a function of the rate of interest. He explicitly writes M = L(r). Economists have known, since at least Irving Fisher, that higher inflation results in higher r. Thus, a rapid increase in inflation will generate a greater excess supply for money, which will be mirrored by an excess demand for goods and bonds (here I am following Patinkin’s analysis); the excess demand for goods, in turn, will put pressure on prices. MMTers believe that because taxes have to be paid in domestic currency the demand for local money cannot decline precipitously. The experiences of the three countries discussed here show that this is not the case. Indeed, and as a large number of economists have pointed out throughout history, when the value of the local currency erodes quickly, holdings of it are reduced to a minimum and velocity increases rapidly.