Thursday , July 29 2021

Inflation: an evil that can not last 100 years

Argentina has been struggling with its economic problems for decades. In terms of inflation, we broke all records. Moreover, if we look in particular at the countries of our region without distinction of the profile of their governments, today they have a digit in the increase of the general level of prices (3.5% is the average inflation of Latin America excluding Venezuela and Argentina) .

Our country tried all kinds of instruments: fixed exchange rate, floating rate, quantity control of money, price control, zero deficit, tax liability law, just to name a few, and none gave results. The only thing that has not been done so far has been to establish a convergence program of all macroeconomic variables within a stabilization plan. For complex and multicausal problems, such as Argentine inflation, it is necessary to implement solutions that involve a variety of economic policy instruments that point in the same direction.

In all these years, we have fallen into "magical" solutions. This government was based on an inflation targeting scheme that, by establishing a high interest rate (positive real), the Central Bank "anchors" the expectations of prices of the private sector. This approach did not take into account the reality of our country: we have an economy in transition that still has many relative price distortions. Indeed, the interest rate is a very weak instrument to impact on reducing the rate of inflation. The communication channel of the Central Bank with the real economy is credit and this represents only 14% of our economy. As a result, this approach implied a very high interest rate, which resulted in short-term capital inflows, valuing our currency.

In short, the result was a sharp exchange rate lag, which marked the genesis of the second quarter devaluation. Like this, the mistakes of allowing short-term capital inflows were paid, causing foreign owners to quickly change their portfolios, generating excess demand and a devaluation in our currency.
Likewise, in the face of this context, there was a poorly managed exchange rate crisis.

In fact, from February to April 2018, there was a confusing policy, with a Central Bank that tried a timid and contradictory intervention, encouraging the savers to "strike." Currency crises are resolved with determination and capacity of surprise, so the market feels it can lose. Thus, the devaluation had its correlation in prices, mainly in foods and industrial manufactures, where the impact is up to 50%. December data (2.6% monthly) are still higher than the average inflation of the first quarter of 2018 (average of 2.2%). In addition, average inflation in the year was 3.3% per month, well above the inflation of 2017 (1.9% per month).

In the future, the first six months of the year mark significant inflation. The new increases for public services will continue to exert pressure in the first few months and additional increases are not discounted. In fact, increases in public transport, gas, water and electricity would provide 3 additional points to inflation, although this could result in 6 points if you add more increases.

Inflation has plagued us since 1945. In order for this evil not to last 100 years, the next government needs to have a comprehensive plan that integrates the tools needed to combat inflation. In emerging countries with similar characteristics to ours, this challenge was faced together by all areas of economic policy. Here, the main element is the convergence towards the same objective in the fiscal, wage and income policies, together with the monetary and exchange policy, to give a precise orientation to the trajectory of prices. Thus, these variables must grow at levels compatible with each other, extending the horizon in the decision making of the private sector, through a "system of beacons" that allows the parameterization of expectations. In the new period 2019-2023, these variables should show a declining and simultaneous nominality of 20% in 2020 to achieve single-digit inflation at the end of the next presidency.

The operational solution to this problem is to establish an "Inflation Targeting Act" that institutionalizes an annual objective through an ad-hoc Committee composed of the following ministries: Finance, Finance, Labor, Energy, Transport and Central Bank, under the coordination of Head of Cabinet of Ministers. Its representatives will be responsible for setting a common inflation target. Each ministry must report on a quarterly basis, and in case of deviations, it will have to present the necessary corrections to the Budget and Finance Committee of the National Congress. In this way, the commitment is effective on the part of the whole government and, together with a legislative accountability mechanism, allows the credibility of the objectives and their permanence over time.

Argentina must face this evil without shortcuts. Only with a plan like the one described with the necessary legislative support will our country be able to leave behind the sad story of being, for several decades, a leader in the field of inflation.

The author is an economist. Director of the Capital Foundation. Former director of the Central Bank of the Argentine Republic

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