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Three Stages of Mexico´s Monetary and Fiscal History:
Growth with Low Inflation, Fiscal Expansion and Reforms
Alejandro Hernandez-Delgado, Felipe Meza, and Ignacio
Trigueros-Legarreta (ITAM)
April 2014
Discussant: Gerardo della Paolera
(Universidad de San Andrés)
Three Stages of Mexico´s Monetary and Fiscal History:
Growth with Low Inflation, Fiscal Expansion, and Reforms
• Analysis of the monetary and fiscal history of Mexico (circa
1978-2009) through the lenses of Sargent (1992), Kareken and
Wallace(1981), Nicolini ( 2010) .
• The authors follow the economics of budget constraints which
includes debt denominated in foreign currency and debt
indexed to inflation.
• This is expressed as in Kehoe, Nicolini, Sargent (2013) as:
The Economics of Budget Constraints
• Rearranging the «canonical» budget constraint, KNS(2013)
obtain equation (1a):
• The debt triplets are to be explained by the inflation tax, the
return on nominal bonds, the return on the indexed bonds,
the return on the dollar denominated debt and the primary
deficit including transfers.
The Economics of Budget Constraints
defining:
• The authors gather data for the 1978-2009 period to
decompose the changes in public debt into (a) the inflation
tax; the return on the government debt and the primary
deficit.
Definitions and Data
• Government: PublicSector + IFDC +IFIBC
𝑑 𝑡 = 𝑝𝑟𝑖𝑚𝑎𝑟𝑦 𝑑𝑒𝑓𝑖𝑐𝑖𝑡 𝑃𝑆 + 𝑛𝑜𝑛 − 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐼𝐹𝐼𝐵𝐶
+𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑚𝑒𝑑𝑖𝑎𝑡𝑖𝑜𝑛 𝑑𝑒𝑓𝑖𝑐𝑖𝑡 + 𝑡𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑠
• Data: InitialProblems to assesstheDebt Stock: mix of
registration at par and marketvalues. ProxiedforNationalDebt
• OnlyPublic Sector, usedmarketvalue of
debtissuedbynationalgovernment net of debts at Central
Bank
Computing the Foreign Debt Ratio
𝑏𝑡∗
𝜃∗ =
𝑃𝑡𝑊
𝑦𝑡 ξ𝑡
• No statistics on the market value of foreign debt: the 1988
debt stock estimated at 64 billion USD composed by the bank
debt at market values plus non-bank debt at face value.
• Then to calculate the yearly stocks use of the flows related to
assets and liabilities from the Capital account.
Difficulties to get indexed Debt
• In the paper, only a consolidated figure for the Total Nominal
debt could be obtained. The ratio θr is implicitly included in
the National Debt Ratio θN.
Fig. 1: Evolution of Nominal, Foreign Debt Ratios, and
Deficit
Fig. 2(a): Change in Nominal Debt Ratio and Deficit
(fraction of GDP)
Fig. 2(b): Change in Foreign Debt Ratio and Deficit
(as fraction of GDP)
Fig. 2(c): Change in Monetary Base to GDP and Inflation
Tax Revenue (as fractions of GDP)
Fig. 2(d): Change in Foreign Debt Ratio and Total Net
Interest Payments (as fractions of GDP)
Results
• In Figure 1 (and 6), primary deficits until 1982/3. After 1986
fall in the foreign debt ratio but increase in the nominal debt
ratio.
• In 2(a) through 2(d), the graphs show if the deficit, total
interest payments and the inflation tax revenues drive
changes in both ratios.
• In 2(b) the ratio of foreign debt seem to respond strongly to
changes in primary deficit; in 2(d) total net interest payments
is closely related to the increase in the Foreign Debt ratio.
Fig. 6: Primary Deficit as a Fraction of GDP
Accounting for total net interest payments
• After calculating the sequences of the debt ratios, the authors
compute net interest on the debt:
and
• They need to proxy the gross interest rate R and r*: for R the
proxy is the yield on the CETE, the interest payments is
calculated as a residual from the total.
• In Figure 4, the interest rate payments on foreign debt is the
main source of fluctuations in total interest payments.
Fig. 4: Total Net Payments on Nominal Debt; On Foreign
Debt and Total Net Interest Payments
Fig. 3: Growth Factor of Price Level and Gross Nominal
Yield on Domestic Debt
Analysis of cumulative changes in debt and their driving
components
Analysis of cumulative changes in debt and their driving
components
• Introduce:
a) A sequence of primary (deficits) surpluses;
b) A sequence of interest payments;
c) The negative of cumulative changes in the money base
(reduces borrowing);
d) The negative in cumulative changes in the inflation tax.
• Results: In 5(a) interest rate payments are the main driving
force to increase the level of indebtedness. In 5(b), the
surpluses after 1983 the main force to reduce the ratios.
Fig. 5(a): Cumulative Change of Nominal, Foreign and
Total Debt Ratios
Fig. 5(b): Cumulative change of Debt Ratios, Cumulative Primary
Deficit, and Negative of Cumulative Inflation Tax Revenue
Fiscal Expansion of 1970s and the Debt Crisis of 1982
• Dynamics lead by sizeable primary deficits (Fig 6); jump in
1981.
• Banco de Mexico dominated by the government (fiscal
dominance).
• Progressive increase in the level of indebtedness until 1982
(Fig 9), when debt constrained , inflationary scenario.
• The stylized facts are explained by the SW model: deficits
need not be inflationary as long as you can finance them by
issuing debt (foreign?), once debt intolerance is present, the
Unpleasant “Fiscal” Arithmetics push you to an inflationary
scenario.
• The “repressed” inflation is a short-run equilibrium when
running continuous primary deficits.
Fig. 6: Primary Deficit as a Fraction of GDP
Fig. 9: Total Debt as a fraction of GDP
Fig. 7: Inflation Tax Revenue as a Fraction of GDP
Fig. 8: Inflation Rate measured with the GDP Deflator (%)
Economic Reforms in the 1990s and the 1994 Crisis
• In 1990’s Independence of the Banco de Mexico, goal is to
maintain the purchasing power of the peso: limits advances to
the Government (Change in Macroeconomic Regime?)
• However, huge internal political shock in March 1994, Colosio
killed. Political Uncertainty; start issues of Tesobonos; sizeable
capital outflows by Nov/Dec 1994.
• Change in the exchange rate regime.
• Sudden Stop? Substituting for short term borrowing ( with
maturities shortening) and the ratio dollar indexed debt to
international reserves increasing) but even then in early 1995
Mexico could not roll-over the short term debt.
• How the facts fit with the model?
Economic Reforms in the 1990s and the 1994 Crisis
• Some stylized facts:
1. Debt ratios not at its maximum, however stock of
tesobonos net of international reserves equivalent to
30billion USD.
2. Interest rates skyrocketed because the expectations of
further devaluations increased and because of tight
monetary policy which maybe the agents believed was to
become unsustainable (role of the external bail-out to
redress those expectations?) due to a potentially
explosive burden of the short-term debt. (here there is a
SW flavor only that maybe bailout meant degrees of
freedom to maintain monetary independence)
3. These dynamics in spite of a contractionary monetary
policy and a pro-cyclical fiscal policy. Smax was not
attained because of bail-out?
Fig. 10: International Reserves and Government Bonds
(in millions)
Fig. 11: Average monthly annualized nominal interest
rate paid by 28 days CETES (%)
A Historical Example of Deficit Dominance: Debt, Fiscal
Deficits and Inflation (Argentina 1885-1893)
Fig. 9: Total Debt as a fraction of GDP
Primary Deficit Pre-Baring Crisis
Primary deficit (in millions)
25
20
15
10
5
0
1885
-5
-10
-15
-20
1886
1887
1888
1889
1890
1891
1892
Fig. 6: Primary Deficit as a Fraction of GDP
Price Level and Exchange Rate 84-1914
Fig. 8: Inflation Rate measured with the GDP Deflator (%)
Sustained Primary Deficits: From Debt Finance to Fiscal
Dominance
“The monetary and fiscal inconsistency
became apparent by the end of the
year 1889. The government, already under a
debt-ceiling constraint and with
its specie reserves almost depleted, had no
choice but to switch from debt
finance to money creation to cover an
ongoing budget deficit. For the 188991 period, the accumulated inflation rate
(163.7 percent) and the accumulated
depreciation rate (152.7 percent) are closely
correlated with the accumulated
counterfactual inflation rate (154.9 percent)”.
Sustained Primary Deficits: From Debt Finance to Fiscal
Dominance
“Before the curtain fell in 1891, the drama
concluded with an economic policy
that had finally exhausted all the available
genuine means of finance and heavily
relied on the inflation tax to finance the
budget. The inflation tax and currency
substitution interacted in unfortunate ways
that exacerbated the fiscal problem.
If there is a high sensitivity of velocity to
inflation (a greater propensity for
currency substitution) then this will imply a
higher inflation rate for the same
level of deficit, all else equal. Moreover,
currency substitution will lower the
base for the inflation tax, requiring an even
higher inflation rate to sustain the
same fiscal gap.» l6