Download The Macro Dimensions of Volatility and Vulnerability: Issues with

The Macro Dimensions of
Volatility and Vulnerability: Issues
with reference to the Indonesia
Crisis 1998--Lant Pritchett
June 19, 2005
Five Issues of Macroeconomic
Crisis
• The relative price of tradable to nontradable goods
• How is the fiscal adjustment (inclusive of
financial sector costs) financed?
• Are real wages flexible?
• Are output falls concentrated in
investment?
• What is the initial allocation of assets and
exposure to macroeconomic risks?
Illustrated with reference to
Indonesia—and potential contrasts
Brief chronology, by period
July—mid
Dec.1997
Thai bhat weakens, contagion to Indonesia, first IMF
agreement (16 banks closed, fiscal tightening), rupiah
sinks from around 2000 to around 5000
Dec. 1997—
May 1998
Soeharto’s health questioned, rupiah sinks again, second
IMF package in January, rupiah sinks to 15,000, liquidity
provided to Banks, money supply doubles Jan-May, in
May Soeharto resigns and Habibie takes over.
May 1998August 1998
New IMF program in July 1998, provides for “safety net”
programs, inflation rapid as CPI doubles, fears of rice
shortages, rice price rises rapidly in August
August 1998June 1999
Money supply brought under control, price inflation
stabilizes, safety net programs (particularly sales of
subsidized rice) scale up rapidly,
June 1999--
Democratic elections held, lost by Golkar (Soeharto’s
party), transition to new government, e-rate stabilized at
Issue One: Relative price of tradables—first
Indonesian experience
• Indonesian inflation had always been modest, real and
nominal exchange rate quite stable (managed float
within bounds)
• The exchange rate depreciated from July 1997 to
January 1998 from 2,200 to troughs of 15,000 or lower,
“stabilizing” between 10,000-12,000—with little domestic
price movement.
• Border prices of importables and exportables sky
rocketed
• Rice prices had, for many years, been stabilized (by a
logistics agency, BULOG) and trade controlled—but
guaranteed a minimum, not maximum price
Indonesian experience: Huge shift
in relative price of food
• While CPI inflation was only around 100 percent
Feb-August 1998, rice prices and food prices
were nearly double the non-food prices
• A great deal of this happened very fast (the price
of rice rose rapidly (my recollection is almost 50
percent) in just three weeks in August 1998
• The rise in the price of food had three
implications:
– Made “macro” measures of poverty irrelevant
– Generalized loss in incomes beyond those affected
– Made analysis of “losers” complicated
Large shifts in relative prices make “macro” impact
measures problematic
• The national accounts data suggested that, although
GDP fell 15% most of this was investment (more on this
below)
• “Real” consumption expenditures fell by only around 35%--hence “poverty” impact appeared small.
• But deflating nominal incomes or consumption by
standard price indices was misleading as they reflected
a much smaller share of food than the consumption
shares of the poor.
• The initial World Bank estimates were wildly off because
it assumed constant relative prices or that GDP deflator
or CPI were good indices for consumption of poor
Relative price shifts generalized the
losses
• The monetization of the fiscal cost
increased price levels (more below) and
this was compounded by shift in relative
price of tradables for the rice consuming
poor (more below)
• Those affected by the crisis were not
necessarily those with personal shocks
(drought, fires, unemployment) but through
prices.
Relative price shifts and analysis of
the “impact” of crisis
• Initial thought was that a modern sector financial
crisis would affect mainly urban and more well to
do (some early evidence of this)
• Differential impacts on three groups:
– Urban consumers of rice (negative, greater for
poorer)
– Rural net producers of tradables (positive, greater the
net production, especially of cash crops—”hidup
Krismon”)
– Rural net consumers of tradables (negative, but not
one for one except for completely landless as
“income” from own consumption increased with
prices)
Key Questions for relative prices
• Are staple consumption items important
tradables?
– Could be little or no international trade and domestic
prices do not adjust rapidly to border prices
– Could be that food is a small portion of consumption
basket (crises in middle income countries)
• To what extent are “poor” net producers of
tradables?
– Differentiates rural sector (depends on the extent and
speed with which nominal wages respond to rural
profits)
– Urban poor who may lack any production hard hit
even with no wage impact
Potential policy implications
• Identifying those impacted by the crisis had to move
beyond those affected on the income side.
• This is particularly problematic if the exchange rate has
“overshot” the expected future real exchange rate
– Do not want to thwart incentive effect by attempting to control
prices
– But if RER overshoots because of asset markets and this affects
stables…
• Indonesia’s rice subsidy entitled each eligible family to
purchase 20 kgs per month at a stipulated nominal price
– “transfer” increased with extent of food price inflation
– Created “entitlement” to some amount of food
– Could be created rapidly due to existing logistical capability
Second Issue: How is fiscal
adjustment financed?
• Particularly acute when a banking/financial
sector crisis creates burdens (the cost of
banking crisis are often large fractions of
GDP)
– Revenue increases
– Increased debt (to smooth fiscal costs)
– Expenditure cuts
– Inflation tax
Indonesian experience
• Concern with liquidity of banks and a
generalized run led government to lend to
banks, this (plus corruption), led to massive
expansion in money supply which led to higher
prices.
• In absence of indexation, particularly in labor
markets, led to massive decline in real wages.
• Real wages fell 50-60 percent—but recovered
quite quickly.
Key Question: Who is “vulnerable”
in a banking crisis?
• Shareholders in banks?
– Almost never happens--“privatize gains, socialize
losses”
– Particularly pernicious when losses are looting
• Depositors in banks?
– Again, rarely happens?
• Public at large?
– Financial system collapse (means of payment,
liquidity freeze up)—perhaps Albania?
– Costs of bailing out banks
• Central bank liquidity (impact immediate)
• Bonds (impact delayed)
Potential policy implications
• Makes targeting those “affected” difficult
as depends on transmission mechanisms
of inflation
• Fiscal pressures make availability of
resources for mitigation of macro crisis
even more problematic (all safety net
programs a fraction of just the interest cost
of a large banking crisis)
• Lessons from Argentina’s collapse?
Issue 3: What is flexible in the labor
market?
• “Fix price” versus “flex-price” assumptions about labor
market clearing make a big difference in analyzing labor
market implications of macroeconomic downturn
• With “flex price” markets where real wages are not sticky
downwards one would expect adjust to come with real
wages, not unemployment—market clears period by
period
• With “fix price” labor markets then unemployment
“clears” the market
• All economies have segments of the labor market with
both features—”informal” markets with no regulation,
tenure security and “formal” markets with regulation
(benefits) and firing restrictions
Indonesian experience
• Classic “flex price” adjustment to shock
• Real wages fell by nearly 60 percent in six months, then recovered
as nominal wages responded to inflation with a lag—to roughly 5-10
percent fall after a year
• “Unemployment” rose by at most a few percentage points (no
benefits, labor market restrictions)
• The monetization of the costs of the crisis plus flexible labor markets
led a crisis that began in the urban formal sector to have generalized
impacts via level of real wages as nominal wages adjusted with a
lag to absolute (and relative price shifts)
• “labor creation” schemes in Indonesia did reach the shocked more
often than “the poor”—but could not be scaled up swiftly enough and
on a broad enough scale to affect aggregate wages.
Policy responses
• “labor creation” schemes in Indonesia did
reach the shocked more often than “the
poor”
– but could not be scaled up swiftly enough and
on a broad enough scale to affect aggregate
wages
– Could not be sustained on a sufficient scale
institutionally for more than a very short
period
Who is “vulnerable” to labor market
shocks in a macroeconomic
downturn?
• “fix price”--the newly unemployed have a large
shock to their income while others have small
shock—suggests targeting “shocked”
• “flex price”—(nearly) everyone’s real wages are
affected (often quite rapidly)
• In a mixture economy some are protected, some
bear income and price shocks, some affected
via labor markets with continued employment
Potential policy implications
• “Unemployment” benefits will protect only the
segment of the population affected via quantity
restrictions
• “workfare” programs have their impact via both
those employed and affected the equilibrium real
wage by augmenting labor demand and perhaps
placing a floor on real wages
• …but large and truly open-ended (available to all
eligible) is difficult to create quickly in a crisis
(possible exception of Chile in 1980s?)
Issue Four: Investment,
consumption, smoothing
• A fall in aggregate GDP can come mostly
through falls in investment, with little change in
consumption—as people smooth by all types of
“coping” mechanisms
• Extent and efficacy of smoothing will depend on:
– How “temporary” is the shock?
– How idiosyncratic (non-covariate) is the shock?
– How liquid are available assets?
• Large unexpected shifts in asset prices
(exchange rates, real interest rates) cause
windfall gains as well as losses
Indonesian experience
• There are HUGE issues with panels (measurement error
is LARGE) but existing evidence suggests that during
large macro crisis:
– Running down of assets was coming as a coping
mechanism
– “social” mechanisms did not seem too important
– Measured “churning” in the income distribution was
large—even in a crisis there were winners as well as
losers
– The dire predictions as the crisis worsened were not
borne out—perhaps due to programs, more likely
resilience and resourcefulness, there were not the
permanent impacts feared
Potential policy implications
• Temporary macroeconomic crisis with universal
impacts (impacts via inflation, real wage falls) of
modest magnitude
• Temporary localized real sector crisis (drought,
terms of trade shock, flood) with large shocks on
affected households then targeted response
possible (smoothing impossible)
• Permanent macroeconomic shock—what role for
“smoothing mechanisms?
Summary: Policy implications of vulnerability due
to macroeconomic factors
• Typology of economy:
– Are staple crops of the poor a tradable?
– How does the labor market adjust?
– What are potential modes of fiscal adjustment
to crisis (at debt limits? Scope for inflation
tax? Revenues or expenditures adjustable?)
– Participation of “vulnerable” groups in the
“modern” economy and available smoothing
mechanisms
Summary: Policy implications of vulnerability due
to macroeconomic factors
• Typology of shock and its propagation
– “real” shock (drought, terms of trade) or “financial” or
“macroeconomic” shock (banking crisis, debt crisis)
– Permanent or temporary—is output expected to
recover to trend or is this is a shift in trend and/or
level of income
– Limited spatially within a country? Will the shock be
propagated (at what speed) via linkages (prices, labor
markets) that make the shock universal even if limited
sectorally in its origins
Indonesia’s experience with macroeconomic crisis and
safety net response
• Crisis appeared limited geographically (modern urban
sector, drought, fires)
• Inflation (with no indexation) and flexible wages (in real
terms) and hyper-depreciation led to rapid
universalization of the impact of the crisis.
• Impact on “the poor” was via relative prices, not
incomes.
• Only program that reached large scale and scope was
subsidized rice
• Targeting was impossible as no “real time” data were (or
could be) available.
• “Workfare” might have worked, but did not.
But Indonesia is just what I happen
to know…
• If the stable is not a tradable, or is not so
important (perhaps Africa)
• If the labor markets are not real wage flexible so
concentrated high unemployment persists
(perhaps East/Southern Europe)
• If the crisis is permanent, not temporary
(perhaps Africa, parts of EE/FSU, parts of Latin
America)
• If indexation implies monetization is not possible
(perhaps Latin America)