The fiscal theory of the price level does not explain very much in the US.  Inflation often soars much higher during periods when the national debt is low and falling (the 1960s) and falls sharply when the deficit increases dramatically (the 1980s).  But the FTPL does explain the inflation dynamics of Argentina:

“The [peso] price action looks like a loss of confidence by foreign investors coupled with some form of “capitulation” by domestic investors,” he added. “Markets need to see a radical tightening in fiscal policy in order to stabilise the situation, and that includes cutting wage hikes in order to fight inflation.

There is also some data that sounds suspiciously NeoFisherian:

Argentina’s peso is again feeling the heat.

The currency has fallen to a new record low of 23 against the dollar after slumping 5 per cent in morning trade on Tuesday. . . .

The declines come despite massive intervention by the Argentine central bank, which hiked interest rates by an unprecedented 12.75 percentage points to 40 per cent in the space of just seven days last week.

As always, however, you need to keep in mind the correlation/causation distinction.  Most likely it’s the high inflation causing the high nominal interest rates, not vice versa.  (Or if you prefer, the budget deficits are causing both.)

Scott Alexander recently linked to a graph showing PISA scores by country and by income deciles within countries. Three that caught my eye were Argentina, Chile and Uruguay. These are three countries with populations of Western European descent, and are also the only three countries in South or Central America with per capita GDPs above $20,000.  But the Southern Cone does appalling bad at taking PISA exams, scoring among the lowest of all countries on the list.  Argentina is even lower than (much poorer) Brazil and Tunisia, something I would not have expected.  Argentina also scores extremely low on indices of “Economic Freedom”.

Argentina’s an interesting case to think about.  It’s a sort of composite of the worst of Chile and the worst of China.  Chile scores extremely high on economic freedom, the only developing country in the top 10 (unless Estonia is viewed as developing).  Argentina ranks 156 out of 180.  China’s sort of the opposite of Chile.  It ranks pretty low on economic freedom (#111), but (probably) pretty high on PISA scores.  I say “probably” because the scores being reported are for Shanghai, which is definitely smarter than the average Chinese city or village.  Indeed Shanghai scores above any other country in the world, including high achieving city-states like Hong Kong and Singapore.  Nonetheless, based on other studies I’ve seen, I am confident that China would still do pretty well on a more national PISA exam.  Perhaps about at Vietnam’s level.  (Vietnam is roughly comparable to Finland, and far above the US, UK or Sweden.)

So Chile and China each have one good trait and one bad trait.  Argentina has the bad trait of each.  Argentina’s a classic example of a glass half full/half empty situation.  From one perspective, you might expect Argentina to be rich.  It’s mostly settled by Western Europeans (I think it might be the most Western European country in all of North and South America), and those countries are usually pretty developed.  But Argentina’s per capita GDP seems to be either lowest in the world for ethnic Western European countries, or second lowest (I had trouble getting racial data for Costa Rica.) A hundred years ago it was among the world’s richest countries.  It has a world-class port, and rail lines fanning out across some of the world’s most profitable farmland.  It’s got lots of mineral resources.  It’s technically sophisticated, completing Latin America’s first nuclear power plant way back in 1974.

Chile’s population is also primarily Western European, but considerably less so than Argentina.  Chile also scores very low on PISA, but not as low as Argentina.  And of course Chile has far more economic freedom.  (Just to complete the Southern Cone, Uruguay is in between the two in terms of education and economic freedom, and also GDP/person.)

China is poorer than the Southern Cone.  But that may be misleading; as it’s clearly growing faster and hasn’t reached the “middle income trap” that the Southern Cone seems to have reached.  China’s high PISA scores are consistent with the high scores in other ethnic Chinese/Japanese/Korean/Vietnamese areas, but NOT other parts of Asia.

I’d like to claim that some combination of economic freedom and PISA scores explains wealth, but I see too many exceptions.  Mexico scores higher than Argentina on PISA tests, and also far higher on economic freedom, but is poorer.  Why?

Sweden is much richer than Finland, despite doing dramatically worse on PISA, and being fairly similar on economic freedom.  Maybe the answer here is that PISA and “economic freedom” don’t always measure what we might assume.  Take the Heritage Economic Freedom Index.  Argentina is down there with countries like Uzbekistan, New Guinea, Niger, Haiti and Afghanistan.  I don’t know about you, but if I were opening a new winery, I think I’d prefer the Mendoza area to Afghanistan or Niger.  Indeed reading the Heritage description of Argentina makes me wonder why it ranks so low. As far as PISA scores, I wonder if they measure the sorts of skills required for a modern economy.  According to The Economist, Swedes are the most computer literate of this set of countries, despite scoring relatively low on PISA tests.

 I do think both the Heritage rankings and the PISA scores are correlated with what we think they measure (which might be ease of starting businesses and keeping the wealth you create for the Heritage index, and ability to do complex jobs for PISA).  The question I have is whether the outliers we see, such as Argentina and Sweden, are due to flaws in these two metrics, or because there are other factors that influence development, which go beyond economic freedom and intelligence/education.

At the bottom, I have (IMF) estimates of GDP per person in 2016 for the top 91 countries.  A few things worth noting:

1.  The US continues to be inexplicably rich.  Among “normal countries” (i.e. not oil rich, tiny, multinational dominated and/or city states) only Switzerland scores higher.  And number three (Netherlands) is more than 10% lower than the US.  We are no longer top 10 in economic freedom, and our PISA scores are mediocre.  So why are we so rich?  Because we are large?  But lots of small Northern European countries are high on the list.

2.  Spain finally surpassed Italy, after many decades of gradually catching up.  Wait, wasn’t Berlusconi going to Make Italy Great Again?  Seriously, I wonder if a combination of population density and regulatory complexity make if much harder to do major projects in Italy than Spain, like large new real estate developments.  Can anyone confirm?

3.  South Korea is now very close to overtaking Japan.  That may be partly due to the fact that Koreans have lower taxes and work more hours.

4.  China finally overtook Brazil, and it looks increasingly like they will overtake Mexico by 2030, (allowing me to win my bet with Talldave.)

5.   Malaysia overtook Greece and will soon overtake Portugal.  It seems increasingly likely that Malaysia will escape the “middle income trap”.

6.  There used to be a lot of articles about how the former Soviet bloc’s transition to capitalism had failed.  But there are now 5 former communist countries that are richer than Greece and Portugal, with the Czech Republic leading the way.

7.  All you need to do is look at countries #31 to #35 to realize that GDP/person (PPP) can be extremely misleading.  I wonder about some of the figures.

Argentina offers an interesting lesson in the relative importance of monetary policy and structural reforms.  During the period from 1991-97 it grew very rapidly with neoliberal reforms.  Then in 1998-2001 the economy experienced deflation.  After 2002 a new left wing government came in and adopted a very inflationary monetary policy.  It also moved away from neoliberalism, adopting all sorts of statist economic policies.

So was real growth higher in the 1998-2001 period or the period since 2002?

It’s not even close.  The period from 1998-2001 was a disaster, one of the worst depressions of modern times.  And since 2002 the economy has seen fast growth, which led to the current government recently winning a landslide election victory.  

Conservatives in America have recently adopted the position that monetary stimulus doesn’t help, even when NGDP has fallen dramatically below trend.  They also believe in pro-market policies and oppose statism (unless they are actually in government of course.)  So it seems to me that Argentina discredits conservatism.  You have a country that got much higher growth from shifting from a deflationary monetary policy to an inflationary monetary policy.  And all this despite the adoption of horrible statist policies.

So are conservatives wrong about markets, or money?

The answer is simple.  They are right about markets and wrong about money.  Argentina shows just how important it is to get monetary policy right.  If you don’t, even the most misguided statist policies can look far better than anything the more pro-market party has to offer.

Even today Argentina is a “failed” economy by any reasonable standard.  It’s no longer one of the richest countries on Earth, as it was 100 years ago.  But it’s also much less “failed” than 10 years ago, an inconvenient truth for all the RBC-types who deny the importance of nominal shocks.

PS.  Nothing in this post should be construed as praising recent Argentine policies.  The monetary policy has been too expansionary, leading to high inflation.  The government has covered up the inflation.   I get all that.  But the depression of 1998-2001 was far worse.  Something the Argentine voters clearly understand.

In a recent paper, John Cochrane discusses a scenario where fiscal debts become so burdensome that the central bank is virtually forced to inflate:

At that point, inflation must result, no matter how valiantly the central bank attempts to split government liabilities between money and bonds. Long before that point, the government may choose to inflate rather than further raise distorting taxes or reduce politically important spending. Argentina has found these fiscal limits. So far, the U.S. has not, at least recently.

Argentina is certainly an instructive case, but I’m not sure it shows what Cochrane thinks it shows.  The government of Argentina adopted a highly inflationary policy in 2002, partly in an attempt to dig out from under a big debt burden.  But what sort of policies preceded that decision?

Around 1990 Argentina began some neoliberal reform, which triggered very fast growth in RGDP during 1991-97.  Then it all fell apart.  Argentina had decided to adopt a currency board as a way of tying the hands of the central bank, to prevent a repeat of the previous hyperinflation.  Big mistake, they should have followed Chile’s decision to target inflation.  In 1997-98 many developing countries got into trouble, and devalued sharply.  Argentina lost competitiveness.  Then the high tech boom caused the dollar to strengthen, even against the currencies of other developed economies.  Because Argentina was fixed to the dollar, their peso appreciated even more.  Now they were hopelessly uncompetitive, and tried to restore competitiveness under the only method allowed by a currency board, lower wages and prices, aka internal devaluation.  Argentina entered a 4 year long depression as prices fell and unemployment rose to over 20%.  The GOP made the exact same mistake in the early 1930s.

With NGDP falling so sharply below trend, the debts became politically impossible to manage.  Just as in the US during the 1930s, a new left wing government came in, abandoned the fixed exchange rate and defaulted on debts (via both inflation, and a reneging on the gold/dollar clause in contracts.)

And in both cases RGDP started growing really fast, despite horrible statist polices 10 times worse than anything Obama could imagine in his wildest dreams.  So much for RBC theory.

Conservatives were to blame for both crises.  So if conservatives want to prevent high inflation (and I certainly do) the best way is to make sure NGDP grows at a steady rate.  We stopped doing that in 2008, and we are now paying the price.  A little inflation now may prevent a lot more inflation later.

At the University of Chicago they are skeptical that wages could be sticky for a long enough period to explain the current unemployment rate.  The new classical economists generally do accept that demand shocks can have real effects in the short run, but think wages should adjust within a year or two.  I certainly would agree that not all unemployment is due to deficient AD, there was also the big jump in the minimum wage and the extended UI benefits.  But I think much more of it is AD-related than most people realize.  Paul Krugman has an important recent post that shows just how sticky wages become near zero percent inflation.  There is a shocking discontinuity in the distribution of nominal hourly wage gains at 0%, a pattern that is not consistent with New Classical models.  Those models work well at relatively high inflation rates, when all you need to do is negotiate new contracts with smaller pay increases, but the adjustment process seems to take longer when many workers need nominal pay cuts, at least if we aren’t willing to provide a bit more NGDP.

PS.  Some people wonder about the title of my blog.  Krugman’s post contains the single most perfect illustration of money illusion that I have ever seen—the distribution of nominal wage rate changes.

PPS.  Krugman has another post on Italy, which suggests why Cochrane’s theory should not be dismissed.  I don’t think his model tells us much about the US.  But it might eventually prove to say a lot about the European periphery.

Those who are as old as I am, and who have read The Economist for more than three decades, can recall dozens of economic crises in far-flung places all over the world.  Thailand, Mexico, Turkey, Indonesia, Brazil, Korea, Russia, etc, etc.  And in almost every case the collapsing economy and banking distress are associated with sharply falling currencies.

But every so often you find a peculiar case; a feeble economy associated with a strong, muscular currency.  I posted this right after the Japan post, because I wanted readers to ponder just how unusual it is for a currency to be strong in an economy that is so weak.  Another example occurred in the US during 1929-33, when the trade-weighted dollar rose in value, even as the real economy collapsed.  The same thing occurred in Argentina in the late 1990s and early 2000s.  Let’s consider what these odd cases have in common:

1.  Deflation.

2.  Real economies that had been doing well prior to the crisis.  Japan was the envy of the world in the 1980s.  The economy of the US in the 1920s was one of the most efficient the world has ever seen, in terms of economy policy.  The business press was very optimistic in mid-1929, as we had trade and budget surpluses, low taxes, weak unions, stable prices, free markets, etc, etc.  Argentina did some neoliberal reforms around 1990 and grew rapidly in the 7 years before the crisis hit.

3.  All three crises saw banking problems.

How can we explain these perverse cases—weak economies and strong currencies?  Perhaps the usual direction of causation was reversed.  Perhaps the strong currency caused the weak economy, by causing deflation.  Indeed, it’s now almost conventional wisdom that money was too tight in the US during 1929-33.  Some blame the drop in M2; some blame the ideology of pegging the dollar to a metal that was itself appreciating in real terms.  But most experts see the problem as monetary, broadly defined. The same is true of Argentina, which attached its currency rigidly (through a currency board) to the US dollar during a period when the dollar was appreciating from the tech boom.  And of course many economists such as Paul Krugman criticize the Japanese central bank for being too conservative, for pursuing deflationary policies.

So it seems to me that the profession does have an answer to the mystery of strong currencies in weak economies.  When this phenomenon occurs, the strong currency is itself the cause of the problem.  It seems that deflation can severely damage a formerly quite productive economic machine.

But (like TV detective Colombo asking “just one more question”) here’s what bugs me.  Didn’t the US economy go down the toilet between July and November 2008?  And didn’t the dollar not collapse, but rather soar in value against the euro during that 4 month period?  So why do almost no economists consider tight money to have been the problem during that period?  Why isn’t that like the US in the early 1930s, Argentina in the early 200os, and Japan in the 1990s?

I’d love to put on a rumpled raincoat and ask Mr. Bernanke that “one last question.”