Federico Sturzenegger at the Institute for Business Development in Argentina (IDEA)
Within the framework of the 52° Annual Colloquium “bridges to the future” organized by the Institute for Business Development in Argentina (IDEA), Federico Sturzenegger shared his vision as Governor of the BCRA on Friday, October 14, 2016.
This is the full speech:
It is a great pleasure for me to share some minutes with you. A long history that has started years ago links me to IDEA, when Pablo Gerchunoff recommended me to participate as thematic advisor to the Committee Colloquium 2003. It was my first contact with people like José Aranda, Marcelo Lema, Luis Cedrola, Víctor Trucco, and much more who participated in the committee that year. The experience seemed to be good and I was invited again the following year. Some years later, when I was holding office as governor of the Banco Ciudad, I became member of the Committee Colloquium, and in 2012 IDEA appointed me to take Andrés Von Buch’s place in the CEOs breakfasts. This has been an honor to me. I say this has been an honor because it involved assuming responsibility to carry on after the leadership Andres had demonstrated in such area for a long time. So, as you can imagine, I feel like home surrounded by friends.
I would also like to congratulate Sergio Kaufman. For many years I have the feeling that Argentina was the upside-down kingdom, as in María Elena Walsh song. A government that instead of governing and managing the public sector was busy telling what you should do. This was always wrong from my point of view. But as wrong as this was, business agenda in general seemed to be more focused on public management instead of business topics. In my opinion, the lack of interest in business topics in businessman’s conferences signaled that an interaction between businessman and the government kept on being an essential element of the business agenda because it constitutes a source of profitability or risks that was impossible to leave unattended. Thus, the ideas of innovation and dynamism which the president was discussing on Wednesday were delayed by a sterile agenda because the target of the government was not to plan for the future but to protect themselves or get a benefit in detriment of the rest of the society.
But, in these new times, where each one is dealing with their own topics that really matter, we see changes in this event agenda which is more focused on business topics. “The cobbler should stick to his last” an old saying reads.
Today we have a government that believes in free enterprise, in economic freedom (no economic licentiousness), in dealing mainly with the improvement of public management which falls under the scope of its jurisdiction. The most remarkable success in these meetings should be that nobody would be interested in listening to public servants say that they will work for macroeconomic stability or predictability of the country because these targets have already been reached and consolidated.
We are undergoing a process, and here I am as representative of one of the economic institutions of the republic. Maybe, it would be fairer calling this meeting “the vision of the BCRA” instead of “the vision of the Governor of the BCRA” because today the BCRA is a team with people committed to the targets, regardless of the position they hold.
In that sense, I am not here to say what you have to do but to tell you what we are going to do; how we are going to deal with our job and our responsibilities.
As Governor of the Central Bank, our main target is to achieve transparency in macroeconomics across Argentina; to be a stable, invisible and solid backdrop. Needless to say, this is not an exclusive task of the Central Bank. A good economic policy requires an effective management by the whole government, a permanent oversight of competitiveness, sustained fiscal policy, a logical and progressive tax structure, among other components.
Within the framework of these groups of actors there is the BCRA, an independent authority from the Executive Power. In fact, its power is delegated by the National Congress. It is the Congress that accepts its authorities. The BCRA must account for its actions to the Congress. You may have noticed that banknotes bear the signature of the Governor of the Central Bank and the President of the Lower House or the Upper House. This is a clear picture that shows where the power of our institution comes from.
The BCRA is subject to the provisions of the Charter which provides for powers and objectives. Among the latter, monetary stability is the first objective. During the next few minutes I would like to discuss the compliance of objectives which we have decoded as to ensure low inflation down to levels comparable to most of the countries in the region and worldwide.
As “time and tide wait for no man”, I will go straight to the point to answer questions about our anti-inflationary strategy, with a focus on the following:
a) Which is the objective of the BCRA as regards inflation for the next years? Are these objectives logical and realistic?
b) Beyond the objective: How can a Central Bank achieve its targets, particularly in a country with historical inflation rate? Regarding what the BCRA is trying to do, how did it work in other countries?
c) Which instruments does the monetary authority have to achieve its target?
d) Which is the role of the exchange rate in this process? Wasn’t it a key element to deflate the economy? Why does the Central Bank insist on shunning the use of exchange rate as a tool or neglecting its current and future fluctuations?
e) Which role do salary negotiations play within this scheme? Are agreed disinflation targets likely to be achieve, if wage guidelines stay above them? What should a businessman infer from the Central Bank’s position on this subject?
As you can see, the agenda is full and intense. So, let’s start.
a) Which is the BCRA estimated inflation rate for the next years? Is it reasonable and realistic?
I believe there is no longer any doubt about our inflation target. The aim of the BCRA is to have a monthly inflation rate of 1.5% or less in the last quarter of this year, an inflation rate between 12% and 17% next year, between 8% and 12% in 2018, and 5% as from 2019.
A few months ago, the announcement of 1.5% inflation rate per month for the last quarter was viewed with considerable skepticism. However, today inflation expectations are virtually in line with the target. What’s more, the average rate of inflation in July, August, September and October shall agree with the target expected. In other words, the target that was deemed unachievable only a few months ago is today a reality and has even been reached two months before the scheduled time.
Even though our targets have a cadence, is it reasonable to think that in a few years Argentina will have a 5% annual inflation rate? Let’s see what happened in other countries.
After dealing with 400% annual hyperinflation during 1984 and 1985, Israel’s inflation rates ranged from 16% to 20% between 1986 and 1990. But, between 1990 and 1992, they could give a final strike to inflation, reducing it to one digit in two years. Secondly, the case of Peru comes to my mind. After reducing its inflation rate from 7500% to 39.5% annually in 1993, they reached an inflation rate of 6.5% in 1997 (by the way, their average growth during these years was 7.2% per year). We can also make reference to Chile’s experience. After its Central Bank set explicit inflation targets as from 1990, its inflation rate decreased uninterruptedly between 1990 and 1998 along two stages: firstly, from 27% in 1990 to 9% annually in 1994; and then, down to 4.7% annually in 1998, though on a more slow basis.
We should also remember that there are three key elements that contribute to a faster disinflation in Argentina vis-à-vis the countries I have mentioned before. Firstly, we are following the footsteps of all the counties that have already dealt with disinflation. We are in touch with all the relevant actors. We listen to them and receive their recommendations, advices and insight about their experience. Secondly, the world is today less inflationary than in the past. There is no “imported inflation” in the real context. And, thirdly, Argentina removed indexation in contracts in the early nineties. Hence, we have no longer to face this issue to deflate unlike many countries that deflated in the past. Indexation linked to past inflation has been the main source of inflationary inertia. Now, such inertia is absent in Argentina.
We, then, conclude that targets are achievable within reasonable terms in practice. I would like to make a last comment. Think for a moment on a scenario in which an initial monthly inflation rate of 1.5% along with a gradual convergence to a monthly inflation rate of 1% by the end of next year imply an inflation rate of 16% on a y.o.y. basis. If you think that inflation will be higher, you are assuming that inflation will accelerate sometimes along the year. But, if you think that annual inflation will be higher than 19.6%, you believe that we will not be able to reduce inflation next year. Let´s go to the second point to persuade you that this is not a realistic scenario.
b) Beyond the target: How can a Central Bank achieve its targets, particularly in a country with historical inflation rate? Regarding the steps the BCRA has taken, how did it work in other countries?
The issue of how to reduce inflation has been analyzed for long. This topic was subject to discussion worldwide (past time is not casual), even though it is still under debate in Argentina. We mainly aim to find out whether the BCRA is able to reduce inflation or else calls for any help (naturally, the fiscal position shall remain sustainable, which I take it for granted in view of the government’s consistent and sustainable fiscal program). When I speak about “help” I mean taking part in salary negotiations, exchange anchors or price agreements. All these formulas have been applied, though with little success, in the past (if this had not happened, we would not have been debating about this topic today).
Regarding this topic, I would like to start making reference to a quotation cited by Mario Draghi in a meeting we shared a few months ago:
“In the last half century central banks have come a long way in how they approach their macro-stabilization functions. As recently as the late 1970s, views still diverged across advanced economy central banks as to the efficacy of monetary policy in delivering price stability. Some, such as the Bundesbank and the Swiss National Bank, were already committed to using monetary measures to control inflation. But others, such as the Federal Reserve and various European central banks, remained more pessimistic in their outlook, believing that monetary policy was an inefficient means to tame inflation and that other policies should be better employed.
Illustrating this view, Fed Chairman William Miller observed in his first FOMC meeting in March 1978 that "inflation is going to be left to the Federal Reserve and that's going to be bad news. An effective program to reduce the rate of inflation has to extend beyond monetary policy and needs to be complemented by programs designed to enhance competition and to correct structural problems.”
In this context of timidity about the effectiveness of policy, inflation expectations were allowed to de-anchor, opening the door to bouts of double-digit price rises. The outcome was a phase of so-called "stagflation", where both inflation and unemployment rose in tandem.
The lesson about policy that rose in this period was that sustainable economic growth could not be separated from price stability, and price stability depended, in term, on a credible and committed monetary policy. Since 1979 onwards —with Volcker as the Fed president— central banks converged towards this approach and accepted to fully meet their objectives regarding inflation. As their renewed commitment to control inflation became understood, inflation rates fell steeply in a context of improved anchoring of inflation expectations. Central banks abandoned the self-absolving notion that price stability depended on other, non-monetary authorities.”
It is worth thinking about the former paragraphs to understand that inflation was overcome in the world because central banks committed to its reduction by resorting to tools which proved to be enough and produced convincing results.
Moreover, I would like to underscore that all the countries which had embarked on a coherent and consistent target inflation program managed to control inflation. According to studies conducted in the BCRA, developing countries that had adopted an inflation target regime reduced its inflation rates from 82% annually on average in a ten-year period before the implementation of the institutional scheme down to 6% annually on average over the following ten years. If we exclude Brazil from calculation, bearing in mind its extremely high rates, a decrease in inflation rates goes from 25% to 6% on average on a term-on-term basis. Within this group we can find Chile which inflation rate fell from 14% to 4%; Colombia going down from 25% to 7%, México from 19% to 4%, and Peru from 19% to 3%. These are some of the many countries which achieved significant and lasting disinflation.
If such countries as put their monetary policy at the service of disinflation could succeed, why we should not? But this leads us to the third question in our roadmap for today.
c) Which instruments does the monetary authority have to achieve its target?
Actually, the BCRA system and operation as well as inflation target regimes in general are fairly simple to explain and understand. However, if this is not clear enough, let us take this opportunity to refresh our minds. As inflation increases the benchmark rate of the monetary policy goes up too (the monetary policy becomes more restrictive). On the contrary, If inflation decreases, the benchmark rate of the monetary policy fell too (the monetary policy relaxes). The use of the interest rate as a key instrument of monetary policy is the rule for all the countries that have adopted inflation target schemes. Interest rates move through three channels: first, the benchmark rate impacts on the rest of the economy’s interest rates, liquidity and credits, which in turn exert an impact on aggregated expenditure; second, the rate exerts an impact on the exchange rate; and the third channel, which embodies a decision on the rate and a transparent and fluid communication boosted by the Central Bank, has an impact on inflation expectations. If society perceives that the monetary authority will be free to use instruments in order to lower inflation, the information about the future dynamics of prices will pass through price formation and wages even before the remaining channels bring about effects.
As businessmen, you are always assessing what to do when pricing your products in terms of other goods. When demand is willing to pay more for your goods, it is not easy to determine whether it is due to a more expansionary monetary policy; whether there is more liquidity and prices of all goods increase; or whether demand increased in particular in terms of some goods. In a high inflation context, businessmen naturally think that all increases in demand are the result of macroeconomic momentum. In this context, all prices will be increasing hand-in-hand with general inflation of the economy.
The level of prices within the economy results from money market equilibrium. If the government issues money at its own discretion, there will be more money in circulation than the amount needed. The price of money, in terms of goods, will fall and this is what we call inflation. In an inflation targeting scheme, the imbalance between supply and demand of money is overcome. As the BCRA is willing to absorb all the pesos the people do not want to have at the interest rate opted for, the engine fueling inflation is suddenly shut down. For this reason, we are early witnessing positive signals of the process of disinflation we are going through.
As the BCRA gains credibility, there will be a change in everyone’s perception about the extent to which fluctuations in demand may be explained in real or nominal terms. Eventually, the nominal stimulus will gradually decrease. This naturally implies that pricing will involve a careful and precise process. If the rest of the prices remain unchanged, any individual increase in prices will trigger, in this new scenario, a rise in relative prices of other goods, which may produce adverse effects on the economic equation of a company.
Thus, the Central Bank has become (in the words of Javier Goñi) a sort of “the reporter of Indy”, or may even be viewed as a sort of “manometer” that gauges the rhythm and pulse of inflation’s general dynamics for you to have a predictable picture before disclosing your decisions on relative prices.
I remember having a meeting with firms in the supermarket sector at the beginning of this year. On such occasion, I explained them our political decisions and told them that even though expansion rates were still high, around 45%, I could ensure that they will be below 20% in May. To achieve such sharp slowdown, the amount of money in circulation had to decrease. We were trying to guide the market and to clarify the scenario in terms of pricing by making the industry know that nominal shocks would disappear in the future. Obviously, at the beginning credibility is not easy to gain, particularly in Argentina, where words count for nothing most of the time. However, in May the amount of money dropped in absolute terms and the annual change rate was well below 20%. The supermarkets sector quickly realized that this time we were going to fulfill our objectives. Accordingly, they moved on the direction of creative sales promotions (buy-two-get-one free, buy-three-get-one free, and buy one get one 80% off, etc.).
We are not complaining. In fact, this change of behavior has embraced the idea of “Seeing is believing” in all countries. It is clear that if we want to be credible, the BCRA is expected to produce positive results. Our commitment to our objectives was evident from the very beginning by contracting the monetary policy upon the establishment of the annual nominal rate at 38%. We then announced that we should not change it until we had clear signs of disinflation. And we succeeded in getting it unchanged for three months. I would like to underscore that we will strive for achieving our targets.
In October we have already embarked on a completely different process so it is doubly important for us to be on the alert. We are seeking to reduce inflation expectation for 2017, which are around 20%, and to get it closer to our target by officially disclosing the targets for the following year. We decided to immediately stop decreasing interest rates that have been applied by the prior monetary authority. Thus, the BCRA assumes this kind of commitment as to its disinflation objective.
I conclude that the BCRA has the same instruments as the rest of the countries to reduce inflation: Hence, it requires no other tool. There is nothing special about us. A few days ago, the governor of the Bank of Israel, Karnit Flug, explained at the BCRA Money and Banking Conference that today inflation is below the annual 2% target. Her challenge is to react to disinflationary external shocks and increase inflation, but for the last three years she could not increase inflation above 0%. She also added that if someone had told her 10 or 15 years before that keeping inflation below the target would be a problem for the Bank of Israel in the near future, it would have been hard for her to imagine such a thing. “And yet, here we are now”, she told me. This situation could actually be the case for Argentina in a few years, with inflation even below its 5% annual target.
The truth is that not even in terms of exchange rates are we special, original or odd. Let’s move on to our fourth point.
d) Which is the role of the exchange rate in this process? Wasn’t it a key element to deflate the economy? Why does the Central Bank insist on shunning the use of exchange rate as a tool or neglecting its current and future fluctuations?
Those of you who have attended our conferences from the very beginning of our management may have already heard about this disinflation process with the explicit commitment of shunning the use of exchange rates as an anti-inflationary anchor.
This is not an arbitrary decision. An economy like Argentina’s needs foreign exchange flexibility in order to adapt itself to such eventual shocks that may arise from global economy. Thus, our real economy, our levels of employment and our industries will be protected and safeguarded from international fluctuations by letting nominal exchange rates to move.
Let me say that the use of exchange rate as an anchor is always appealing. It aligns expectations and caused the interest rate to plunge. But what is easy at the beginning proves to be balanced out with some problems afterwards. With a fix exchange rate, the economy has no resources to face different shocks. So these adjustments, sooner or later, are made in a more disruptive and painful way. It is not necessary to delve into this topic because our history has taught us enough.
We have chosen a harder way to decrease inflation without resorting to the exchange rate as a tool. But moving in this direction is well worth the effort. We will rise to the challenge of building an economy strong enough to face fluctuations and hard news free of such recessions or crises that happened in the past. We will rise to the challenge of building a more stable economy that may experience softer real cycles.
Thus, foreign exchange flexibility is a must to achieve our objective of protecting the Argentine economy from the international context. Let us see a characteristic example of the advantages of this foreign exchange system. Last year Colombia suffered the adverse effects of an oil price drop, going from more than 100 US dollars a barrel to less than 30 in a few months. Against the backdrop of such awful shock, the Colombian government devaluated currency by 70%. Even so, inflation moderately increased from 4% to 7% per year, and economic growth was sustained at 3.1% over the same year.
What I have explained so far is quite easy but the question is whether this works or not considering that “when an exchange rate increases or decreases, so do prices”. Following this line of thought, many of my colleagues and many of you may think that the use of exchange rates as an anchor is unavoidable.
It is true that countries with high inflation are likely to experience similar rises in their price levels and exchange rates. But this does not mean that the exchange rate triggers the prices. Rather, both are the consequence of a third variable. Let’s put it simple: prices go up because the amount of money in circulation increases faster than the stock of goods required by people. Thus, prices go up and so does foreign currency (which is nothing other than a third price).
The point is that people usually associate “a rise in the US dollar value with a rise in prices”. In fact, they should come up with the idea that “as a result of an excessive issue of currency, prices and the US dollar value rise”.
Hence, when you move on to a floating exchange rate regime with controlled issue of currency, the relation between exchange rate fluctuations and changes in the general level of prices is no longer significant. The latter actually changes due to the monetization of the system. In other words, inflation pass-through to prices loses relevance.
Some of you may think that I am pulling your leg. But let’s consider some examples. In the case of Mexico, if you calculate the relation between the exchange rate and inflation since 1970 the figure is 80%. But if you analyze only the last 15 years, this figure falls to 3%. In the case of Chile, the decrease recorded is also significant, going from 92% to 28%. In Peru, such correlation shrank from 88% to 20%. Where inflation is kept under control through monetary policy, prices stabilize around the objective established, and so the real exchange rate adapts to any such disturbances in supply or demand as a country have to face.
Obviously, for you to abandon the idea that “if the dollar value rises, so do prices” and welcome the belief that “if the dollar value fluctuates in the face of an external shock but entailing no issue of currency, prices stay still”, you belong to the group that hold that “seeing is believing”. Let´s discuss an event that happened this year; the first external shock that put our nascent floating exchange rate regime to the test.
You may wish to look at the chart attached to the presentation to follow my explanation. On the week after the Brexit referendum that took place on June 23 in the United Kingdom, the dollar value rose by 6.5% in our country. However, Pricestats —the provider of daily inflation indices— shows that prices were not pushed up over such week. In fact, prices grew even below the trend recorded in the previous four weeks. If we extend the term one week more, we will find out that the exchange rate reverts partially and ends up with an accumulated depreciation of 3.5%, Pricestats inflation falling below the previous trend (down to 0.22% weekly against 0.37% weekly over the previous four weeks average).
We are certainly not resorting to the exchange rate as an inflationary anchor, which is conclusively proved by the fact that, for instance, during this year the multilateral real exchange rate fell by 22% y.o.y., accumulating an increase of 25% over 2016 in terms of the figures of December before the exchange clamp was removed. It is interesting to analyze the development of Brazil’s bilateral exchange rate which depreciated 47% in y.o.y. terms. So, regarding salaries, the last question is:
e) Which role do salary negotiations play within this scheme? Are agreed disinflation targets likely to be achieve, if wage guidelines stay above them? What should a businessman infer from the Central Bank’s position on this subject?
Many of you may think that it is very difficult to reach an inflation target if the union salary is outside the target range. But the picture is not really true.
As regards costs, it is important to see how the average real salary changes from year to year. In a context of constant inflation, average real levels remain stable from year to year by dint of collective bargaining thus equaling last year’s inflation (if depicted in a chart, we could notice that the variable would show homogeneous ups and downs that repeat year after year). If inflation accelerates, collective bargaining should be higher to past inflation because higher inflation means that salaries lose purchasing power faster, which calls for an additional adjustment to compensate that lost. But if inflation falls (as is currently the case in Argentina), a collective bargaining increase should be less that past year’s inflation in order to keep an average real salary stable. But this amount will depend on the time of the year when collective bargaining takes place and the intended average increase in the real salary subject to union negotiation.
For example: if last year’s inflation is 40% and the following year is zero, a 20% increase will be necessary to keep the average real salary stable.
Anyway, each sector has a really different and particular situation. There are sectors which have been experiencing a decrease in the real salary for ages, while others have obtained increases.
But there is an additional argument which indicates that real salary should increase next year. Greater predictability and certainty of our economy, an evident reduction in the cost of capital and a great tax reduction implemented by the national government pave the way for a scenario where salaries may increase in real terms. It would sound rather strange to hear that costs decrease because taxes decrease, that costs decrease because cost of capital decreases as well as labor cost. So, as a real salary is likely to rise due to a decrease in other costs, this affect in no way the disinflation scenario.
In turn, we have learnt from experience that real salaries tend to grow during disinflation years. For example, under Argentina’s Convertibility Plan, inflation decreased from 84% annually in December 1991 to 17.5% in December 1992. The question would be, then, how salaries evolved during this year of disinflation? In fact, they increased 4.2% in real terms vis-a-vis the previous year’s average.
vTo sum up, increases in salaries will vary by sector. In some cases, salaries will rise above the inflation target but well below last year’s inflation in order to keep the real salary stable. Hence, each sector will define whether their real salary levels will increase or not. I imagine that in this case increases will depend on rises, or not, in the productivity in each sector in particular).
All in all the role of the BCRA is to inform businessmen and workers of the future inflation dynamic, which will serve as a basis for salary negotiation purposes. We do not consider salaries to be an anchor. On the contrary, we believe that the coordination of all actors and information-sharing on prices development with all of them are of vital importance for businessmen and workers to make informed decisions.
Well, I think we have answered, or at least I believe I have answered, many of the questions whose answers you expected from this BCRA. I would like to end up by assuring you that the Argentine society can now rely on a monetary authority that is determined to preserve the value of our currency. We will not make things up. We will merely continue moving in the direction of such countries which have already succeeded. And I hope that in 2019 when we will reach an inflation level comparable to such other countries, I will attend a colloquium as an enthusiastic observer rather than a speaker. I also hope that I will attend a colloquium where the attendance of officers is no longer required and discussion revolves around several axes: the opening of the African market to our food and industrial products; the issue of corporate debt instruments in pesos at 30/40 or 100 years; the placement of our food and dairy production in terms of world demography; the development of IT and automatization in Argentina; or infrastructure problems posed by the new industrial or petrochemical pole that would have developed along route 22 as a result of the success of energetic production in the river basin in Neuquén. I further dream of a panel of speakers telling us the story of young men and women who have succeeded in “hunting unicorns” to enrich entrepreneur tradition in Argentina.
This is the Argentina we dream about, and this is our contribution. From the BCRA we expect macroeconomics to be no longer a matter of concern for speakers. Thus, we will have accomplished with honor the task to serve Argentine people.
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October 14th, 2016
