Latin America’s lessons for Biden
Experience has taught us that once inflation is ingrained in an economy, getting rid of it is no picnic – even if you are an economic superpower
It’s easy to discount what Latin America may have to teach the world about running an economy. After all, what can a region perpetually embroiled in intractable problems possibly teach us? In this part of the world turmoil is the norm. In reality, though, the basic problem in Latin America is not its chronic economic instability, but the inability of its leaders to learn from experience, and their propensity to keep pushing policies that have already proven disastrous. I call it ideological necrophilia – the passionate commitment to dead ideas.
This, however, does not mean that more advanced economies can’t learn from Latin America. In fact, here is some advice from Latin America that President Joe Biden and his team would do well to keep in mind.
The first is not to ignore the deficit. The idea of brushing aside the consequences of spending far more than a government collects in taxes has a long history, and is the subject of a fierce academic debate. In 1932, John Maynard Keynes argued that recessions can be remedied with dramatic increases in public spending. In 2002, then-US Vice President Dick Cheney blandly asserted that “deficits don’t matter.” That debate is very much alive. In 2020, economist Stephanie Kelton published a book titled The Deficit Myth. In this bestseller, the unorthodox economist explains why the so-called Modern Monetary Theory means that a government that controls its currency can increase public spending as much as it wants. Again: fiscal deficit doesn’t matter.
It has become easy to ridicule economists who sound the alarm about inflationary spikes that never seem to materialize
It’s clear that President Biden has decided to gamble on a huge increase in public spending not causing any collateral damage to the economy. More specifically, he is betting that it will not cause inflation. Or that whatever inflation it does cause is not a serious problem. Or that the increase in prices will be only temporary. Perhaps he feels that if inflation does become rampant and prolonged, it can be brought to heel through other economic policy instruments, like interest rates. Economists call this fine tuning: trying to adjust economic policies in order to cool an economy overheated by increased public spending. But most importantly he seems convinced that, as the deficit doves argue, inflation is simply no longer a problem in advanced economies. For decade after decade, those who have predicted damaging inflationary outbreaks in the US or Europe have been wrong. As a result, it has become easy to ridicule economists who sound the alarm about inflationary spikes that never seem to materialize.
But as any student of Latin American history knows, the region’s presidents have been serving up this same kind of explanation for why inflation is not a threat, ad nauseam in fact, while they carelessly increased public spending, and almost always with disastrous results. It turns out that in these countries the deficit does indeed matter. A lot. The consequences turn up everywhere: currencies are devalued, debt skyrockets, capital flees, investment stalls and, of course, prices spiral with devastating effects on the least well off. The United States and other developed countries have conditions and institutions in place that makes them less vulnerable to this dynamic. But not immune. The complacent tolerance for inflation can be disastrous.
The Latin America experience has been that once inflation is rooted in the economy (in prices, contracts, wages, and people’s expectations), it is excruciatingly difficult to root out. And that attempts to fine tune the economy usually fail. What’s more, big increases in public spending spark waste, inefficiency, and corruption.
Larry Summers and Olivier Blanchard, two highly respected economists, believe that Biden’s huge spending binge will be inflationary
It is true that Latin American countries do not control the currency they borrow in, while having the dollar as its currency opens up possibilities for the United States that other countries just don’t have. Even so, the fear of inflation is already making itself felt in the US. A survey by Fortune magazine found that 87% of American adults are concerned about it. Private investors are already restructuring their portfolios to make them less vulnerable to inflation. Larry Summers and Olivier Blanchard, two highly respected economists, believe that Biden’s huge spending binge will be inflationary. Summers, a former US Treasury secretary and adviser to Presidents Clinton, Obama and Biden, accused the US Federal Reserve of misreading the economy: “The primary risks today involve overheating, asset price inflation and excessive financial leverage and subsequent financial instability.” Martin Wolf, the influential economics columnist for The Financial Times, wrote that “doubts about the Fed are reasonable. We know that it is politically easier to loosen than to tighten monetary policy… Lobbies for cheap money have strengthened, while those for prudence have weakened.”
If deficit spending enthusiasts like Paul Krugman start to hedge their bets, it’s time to look again to the Latin American experience. The influential Nobel laureate has just written that, although he does not believe that inflation will be a problem, “this does not mean that the entire Biden economic program is going well. It may indeed end up being overly ambitious.” Translation: it could very well cause inflation.
When the economy of a Latin American country becomes unstable, its own people pay the consequences. When the world’s largest economy becomes destabilized, absolutely everyone pays the price.