Federico Sturzenegger, Governor of the BCRA, opened the 21st Global Economics Symposium today organized by the Tel Aviv University under the heading Economic and Financial Outlook: National and International Perspectives.
The full speech is as follows:
It is a pleasure to be here today at this Global Economics Symposium 2016. I remember that last year I had to cancel my presentation at the last minute given the hectic times of elections transition. Now that the Argentine society has cast votes, I can be here today being certain that we have already gone part of the way with an adequate insight so as to analyze the BCRA’s main focus: the evolution and perspectives on inflation in our country.
This implies reviewing the strategy that is, and will be, followed in the future to reach the 5% annual inflation target in 2019.
At present, we need to clarify two relevant issues. As you may know, August will show a significant deceleration of inflation. When I say “significant deceleration,” I am not referring to the deflationary effect of reversal of rates. On the contrary, the BCRA has analyzed the likelihood of fixing monthly inflation target below 1.5% for the last quarter this year. We may, indeed, reach that target two months earlier, without taking into account the effect of rates.
Given this situation, what can we expect from monetary policy? This is one of the topics I would like to address.
The second topic is about the relationship between monetary and fiscal policy, an issue which has not been fully discussed at the BCRA but has been thoroughly discussed among analysts involved in Argentine macroeconomics. The question is whether fiscal gradualism endangers the disinflationary objectives of the BCRA or not.
I will now move ahead to the key conclusions in order to avoid holding these issues in abeyance for long. Regarding the first topic, I will conclude that the August slowdown does not suffice to believe that we should relax our monetary policy.
On the other hand, I will endeavor to support the idea that fiscal gradualism proposed by the government does neither threaten nor condition our monetary policy.
Fighting Inflation
As we all know, Argentina has gone through chronic inflation for many years. This seems surprising today given that virtually most countries have learnt to consolidate a macroeconomic plan without inflation.
For this reason, I would like to start by depicting the way other countries have fought to achieve, and even keep, low inflation. In particular, I would like to share with you a comment Mario Draghi made in a meeting a few months ago.
Draghi said:
“In the last half century central banks have come a long way in how they approach their macro-stabilisation 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 inflation rate 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 policy lesson that emerged from this period was that sustainable growth could not be separated from price stability, and that price stability in turn depended on a credible and committed monetary policy. From late 1979 onwards—with Volcker’s assumption of the Fed chairmanship—central banks converged towards this orientation and took ownership for fulfilling their inflation mandates. 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.”(1)
We should bear this in mind to understand that inflation was defeated in the world because of central banks’ commitment by resorting to tools, which proved to be enough, and produced conclusive results.
We have learnt from such successful experience that the BCRA’s independence is of vital importance. This independence is essential because an important part of the agenda to keep inflation low calls for understanding that the commitment to reduce inflation will not be determined by political emergencies or short-term targets. Even if the BCRA’s target seeks to achieve a low inflation rate and dynamic economic growth, monetary policy should not be so conditioned to an adverse effect given that the inflation rate will only be low if the BCRA does not give in to short-term targets.
Anyway, as we know, inflation is reduced by means of an adequate monetary policy, and disinflation processes are not complexity free given the need to coordinate agents’ expectations among one another within a new schedule, on the one hand, and such expectations in light of the path towards inflation reduction sought by authorities, on the other.
As regards this point, it is important to bear in mind that there is no particular feature in our disinflation process. Rather we have faced the same problems as such countries that underwent disinflation.
For instance, during Canada’s disinflationary process, Gordon Thiessen, Governor of the Bank of Canada, said:
“A distinction should be made between reducing inflation and maintaining it at a low level. Reducing inflation requires a downward adjustment in inflation expectations and may entail transition costs, which is not the case with simply maintaining low inflation. It is generally agreed that the gains achieved by reducing inflation exceed transition costs when inflation is high.”(2)
In our new monetary regime, the BCRA sets inflation targets and resorts to all the instruments within reach to achieve them even if that implies fixing the interest rate at 38% for several months. In this new regime, monetary policy will not adjust to inflation expectations, but will ensure that the expectations and actions of players are consistent with the BCRA’s targets. That was exactly what Draghi referred to.
Therefore, it is central to start see these expectations and taking them as a benchmark for decision-making processes. Now, let’s consider the chart on the inflation expectations during April. As you can see, at that time, a sharp decline in inflation was assumed during the year.
Inflation Expectations and Retail Prices
We then claimed that our objective for this year was an inflation rate below those expectations and, a few months later, we set a 1.5% or lower monthly inflation target for the last quarter.
The chart also shows inflation expectations to date, from which we can conclude they have remained well anchored. In turn, the dotted line shows where we stood vis-à-vis our initial aim. Likewise, it shows inflation expectations for 2017, which stand above our hopes, seeking an inflation rate even below 17%.
Why is it so important to internalize these expectations? Just for a simple reason. Many of the people here today are involved in price and wage formation. And the decision on prices and wages cannot be detached from expectations about what will happen with prices in the future.
In other words, let’s imagine, for instance, a 0% inflation rate for next year. In that case, if you negotiated wages so as to compensate for past inflation, you would be fixing real wages well above the previous year. Why? Because the adjustment implemented would not be followed by future inflation, keeping real wages at that initial value. Hence, given that the initial value of last year’s wages lost purchasing power in the face of inflation along the year, average wages would be higher in 2017 compared to 2016.
You may want to move in that direction and it would be all right, but I would like to point out that the decisions about prices and wages should not be taken in the vacuum; rather, the development of expected prices and wages should be taken into account.
An inflation targeting regime becomes fruitful in defining and accomplishing such expectations, and helping to coordinate the expectations of all economic agents.
If this new regime is not clearly understood, expectations will be detached from monetary authorities’ measures, which will in turn make the following disinflation process harder, as the Governor of the Bank of Canada said 20 years ago.
Now, let us suppose we understand the mechanism and inflation targets are clear: I would like to emphasize the 1.5% monthly inflation rate of the last quarter and place inflation expectations for next year below 17%. Anyway, someone may wonder “why will it work?,” “how could I know that inflation targets will be attained?”
At this juncture, it is important to go back to Draghi’s comments and to bear in mind that inflation is defeated in the monetary market. Price level is nothing but the representation of the price of money. If there is more money than the amount people want, money price will fall or, in other words, the price of goods will rise (relating to money). This phenomenon is called inflation.
That is, whenever there is more money than what people demand (either because of a rise in supply or a decrease in demand), there will be inflation. Therefore, the key to fight inflation is to strike a balance between money supply and demand. Upon the consistent implementation of an institutional system aimed at balancing the domestic monetary market, the “engines” that give rise to inflation come to a halt. Thus, a schedule with these characteristics that matches monetary supply and demand will enable inflation rate to fall dramatically in Argentina.
In addition, we have explicitly stated a clear operating rule: the BCRA will keep a positive real interest rate with an anti-inflationary bias until the final target is achieved. This requires that nominal interest rates decrease as inflation and inflation expectations go down.
Anyway, let me digress for a while: the concept of a positive real interest rate, even if low, has mounted considerable resistance within the business community. However, it is worth noting that a positive real interest rate will not only ensure a path towards disinflation but also provide depositors with a reasonable return. In my view, this is the way towards both a decline in inflation levels and growth in deposits and, eventually, credit. This has been longed for for decades, but it was a sterile thought, as we could never develop credit in the absence of deposits and we cannot have deposits if we do not protect and compensate depositors.
Reaction to August’s Inflation
Going back to inflation, we may ask, “What happens when we achieve inflation targets in a given month as it is likely to happen next August?”
If nothing goes wrong in the next few days, we estimate this month inflation will stand below the 1.5% expected for the end of the year.
In spite of this early success, the BCRA holds that reasonable conditions for monetary policy loosening are not yet in place for a number of reasons. Firstly, an inflation reduction in a given month does not flag a sustained decrease in inflation level because a persistent disinflationary process needs several months for consolidation, even if core inflation decreases, which is presumably exempt from seasonal effects or that of regulated prices. Secondly, inflation expectations for 2017 are still above the BCRA’s expectations. Thirdly, the way towards reaching a 5% annual inflation target is still far away.
To sum up, the BCRA will go on acting with due caution to ensure the consolidation of a disinflationary process.
Monetary and Fiscal Policy
Let us move on to the second topic: the relationship between the fiscal situation and inflation. Both the theory and Argentina’s experience indicate that the issue of inflation is raised when the central bank ends up defining its monetary policy according to the Treasury’s financing needs. This is called “fiscal dominance of monetary policy.”
Being aware of this problem, we have been working together with the Ministry of the Treasury to define a fixed amount in pesos (ARS160 billion—nominal value—for 2016), which clearly restrains fiscal dominance. In turn, that amount was assessed together with the Ministry of the Treasury to be consistent with inflation targets. This value will fall in real and nominal terms as long as inflation falls.
But this is not the only thing analysts are discussing. Many of them openly criticize the government for following a policy of excessive fiscal gradualism, for doing little to lower the high inherited deficits and to ensure fiscal consistency.
Today, I would like to give you three reasons why the BCRA is not concerned about fiscal gradualism.
The first reason is that, at present, our public sector bears a low indebtedness level with the private sector, which—coupled with unprecedented conditions in terms of funds availability—implies that the government has a high level of financing at hand. This enables to lower the transfers from the BCRA to the Treasury and to analyze the fiscal issue from a long-term perspective.
The second one is related to the government’s significant efforts made in the fiscal field as evidenced by its will to assume the political cost of reducing the number of subsidies and to sustain energy policy. The key point here is that fiscal efforts have been focused on both reducing the deficit and lowering taxes.
The reduction of distortive tax rates may imply a loss of short-term fiscal resources. Tax pressure drop, which is at present one percentage point lower than last year in terms of GDP, is probably the best news of 2016. And this tax drop is basically oriented towards improving real wages both indirectly—by improving conditions for profitability in the domestic economic activity—and directly—by lowering the income tax or giving part of the VAT back to some beneficiaries. Above all, this gives rise to the right incentives for the economy to grow.
The third reason is not so much referred to, but it is very clear to all of us who have accompanied the current President in his former mandate in the City of Buenos Aires. This reason is not so much related to the fiscal situation; rather, it is concerned with public expenditure quality as a whole. From a macroeconomic point of view, the improvement of expenditure quality is comparable to reducing deficit because resources are saved in the private sector.
Therefore, a review over statistics of public employment in the City of Buenos Aires during the current President’s mandate shows that the number of public employees grew 7%. Nevertheless, it is worth mentioning that there has been an underlying change in priorities as evidenced by the 19% increase in the number of teachers, doctors and police officers. Today, these improvements in the efficient management of expenditure—which can take place against a backdrop of increased expenditure and employment as experienced in the City—are replicated in all administrative areas. At present, tenders for public works are submitted for half the price of last year but, more importantly, public works are given priority according to their social profitability. These coordinated efforts are the prelude to improve our efficient management of the national public expenditure, which will be critical to boost our economy’s productivity. And I am sure this will happen.
Thus, the BCRA holds that the fiscal scenario does neither compromise nor entail risks to the government’s anti-inflationary policy given the government’s experience in administration and its efforts oriented towards lowering taxes, and because the government has time ahead.
In addition, the BCRA supports that this anti-inflationary policy is not at risk because the government is determined to set an agenda on the reconstruction of investments and formal employment in Argentina and, among these objectives, on the reduction of inflation.
Argentina should adopt a positive attitude to become a normal country, which means being predictable and reliable. It also implies telling the truth. Moreover, being normal stands for a country where people do not need to think about price increases every day, or to be interested in listening to the Governor of the BCRA talk about inflation. We dream of a country where macroeconomics is no longer a matter of concern but a strong and invisible support for everyone’s development. Finally, we do not seek to be original; we only need to work consistently.
(1) Passage from a speech by Peter Praet, member of the Executive Board of the European Central Bank, at the LUISS School of European Political Economy, April 4, 2016, Rome.
(2) In Inflation Targeting: Lessons from the International Experience by Ben Bernanke, Thomas Laubach, Frederic Mishkin and Adam Posen (1999, Princeton University Press).
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Federico Sturzenegger, opening speech at the 21st Global Economics Symposium 2016 today organized by the Tel Aviv University
