The XX Workshop on International Economics and Finance took place on Monday, March 20 and Tuesday, March 21 in the Dr. Ernesto Bosch room of the Central Bank of the Argentine Republic.
The event was organized in conjunction with the Economic Association of Latin America and the Caribbean, the Central Bank of the Argentine Republic, the Inter-American Development Bank, the World Bank and the Torcuato Di Tella University.
Federico Sturzenegger, president of the BCRA, closed the event:
First of all, I want to thank the organizers of this conference for giving me the honor of closing the event. It has been a real pleasure to be able to receive them, especially with so many friends present and for so many years. We have learned a lot in these two days.
Like all the events we do at the Central Bank, the conferences have been recorded and will be recorded on the website. I am sure that they represent very valuable material for our profession and our students.
Today I want to talk about two fundamental objectives of economic policy: equal opportunities and economic growth. I think I am not wrong if I say that there is a general consensus that these are two first-priority objectives. The interesting thing is that the policies of the Central Bank play a key role in its fulfillment, but in a peculiar way: they aim at both objectives simultaneously. The famous dilemma between equity and growth does not appear when we refer to the missions of the Central Bank.
That is why today I want to speak to the academic community. I would like to review with you these objectives from this perspective, to better understand how they work and what they entail. I hope to be able to excite you so that you ask more questions about these topics, and in the process contribute to deepening the value of the agenda that this BCRA is pushing.
Although the two objectives I mentioned are backed by a consensus shared by the vast majority of the population, this does not mean that there are no forces that permanently seek to divert the meaning of policies. I give an example. If one objective of this BCRA is to develop the financial system, which, as we will elaborate below, we believe helps in terms of equity and growth, we will surely face opposition from those who benefited from a financial system characterized by the transfer of implicit subsidies from the depositor to the borrower of a loan at a negative real interest rate. Much of the work of my favorite economist, Mancur Olson[1], and the more recent work of Acemoglu and Robinson[2], focus their attention on these problems (the logic of collective action in the former, and the construction of democratic economic institutions in the latter), which help us to understand that the struggle for policies that tend to the common good is an everyday task.
This is where the role of academic economists comes into play, in fact there lies the value of having independent, pluralistic universities, where topics are studied and can be talked about without being conditioned by the particular interests of any sector. That is why it is very important that they get involved, and contribute to giving an objective vision to the policy issues that are discussed in the country.
Let’s get started then. From our role as central bank, we have two fundamental tasks related to guaranteeing equal opportunities and stimulating economic growth in the country.
First, we are responsible for ensuring access to capital. This implies guaranteeing that the conditions are in place for there to be savings, and that this savings can be professionally intermediated by the financial sector, thus establishing itself as a link with investment and financing of ventures.
Our other task is to reduce inflation levels in Argentina, since inflation is one of the most regressive and distorting taxes.
It is difficult for us to achieve equality of opportunity or economic growth if we do not have intermediated savings and if we do not combat inflation.
When we look at it in historical perspective, we cannot help but say that our institution has failed to achieve both of these goals in the past. Unfortunately, we must recognize that it has failed dramatically. Not only does Argentina have one of the smallest financial systems in the region, but it has bequeathed its country a systematically bankrupt currency, with Argentina reporting one of the most pronounced inflationary levels in history.
But the important thing is to understand our own failures. Only by recognizing them, and correctly diagnosing why they occurred, can we reverse this situation.
a. The role to be played by the financial system
Let us then address our first concern regarding equal access to credit. I am sure that it is not lost on you that the size of our financial sector is far from the average of other countries in the region. To be graphic, while total credit here does not exceed 12% of GDP, in Chile it represents 90%, about 60% in Brazil, and 50% in Bolivia. If there is no deep financial system to ensure abundant access to credit, only those who already have capital will be able to implement their ideas and projects. The discrepancy with other countries is so great that it should be easy for academic work to elucidate what has happened (in a minute I will give you my interpretation).
However, this situation, which is so atypical compared to the region, has been with us for several decades. In the last Monetary Policy Report[3] we published a growth accounting exercise, in which we found that the contribution of the capital factor to Argentina’s economic growth between 1980 and 2016 was continuously negative. In other words, our country, quite simply, was not able, at any time during all these years, to accumulate the capital necessary to boost the growth of the economy. To be more precise, the only thing that was done was to deaccumulate capital per unit of product. Of course, I invite you as academics to review this work, to deepen it and discuss it.
Obviously our diagnosis is clear. During almost all those years in Argentina, negative real interest rates prevailed, which scared savers away from our currency. In this context, the financial system was incapable of establishing itself as a link between savings and investment. The punishment of depositors represented by negative real rates caused a continuous flight of our currency, and therefore of our financial system.
So, we find that we have a country without locally intermediated savings, therefore, without credit, with detrimental impacts both in terms of equity and long-term economic growth.
Developing the financial sector is generating a vehicle that allows a greater number of people to obtain the necessary capital to finance and make their productive ventures a reality. There are few more effective ways to ensure greater equality of opportunity than deepening our financial system. A small system is equivalent to a country where only the rich can invest. We see in that country the proliferation of family dynasties of entrepreneurs, when what we would like to see is a geographical and social kaleidoscope in the processes of capital accumulation. This relationship is direct. It does not merit much discussion. Academia could give us statistics on social mobility in Argentina, or on the concentration in the processes of capital accumulation. If we become aware of how much we lost in terms of social mobility, we will also gather support for policies that seek to recover it. Hopefully someone here will be enthusiastic about addressing these issues.
Of course, there is also the issue of the relationship between the development of the financial sector and growth. There is a direct relationship that is: more capital, ergo more growth (whether or not they believe in endogenous growth models). But today I want to focus on two aspects that relate growth to the financial sector, which I consider to be fertile ground for you to analyze in greater depth: 1) the relationship between access to capital and productivity, 2) the relationship between a repressed financial sector, subsidized credit, and impoverishing growth.
a.1. Equal opportunities and productivity
In a world without extended access to credit, people with greater initial resources have more opportunities to develop their projects than those who do not have such funds. People with good ideas but no capital are left without implementing their ventures, or would do so on a smaller scale, probably less than optimal.
Francisco Buera, in a paper published in the American Economic Review[4](2011) deepens, in the context of a general equilibrium model, the idea that, in a world without sufficient access to credit, the growth of companies is slower, good ideas take longer to implement, there will be a tendency to choose projects with a smaller scale, and with shorter time horizons. All this set of consequences leads to a long-term equilibrium in which the productivity of the economy is lower, wages are lower, and access to opportunities is more unequal.
It is interesting that one of the few sectors where we have witnessed the emergence of large, new companies and new entrepreneurs (Globant, Mercado Libre, OLX, etc.), has been in the software sector, which, precisely, is a sector with little demand for capital. Janice Eberly[5] (2016) shows that these activities are not very capital-intensive. But it is a palliative that we cannot bet on.
a.2. Impoverishing growth
In a country without intermediated savings, credit becomes scarce, as it could not be otherwise. Of course, there is no raw material. So the most important demand that is heard is that “there is a lack of credit”. As there is a lack of credit, they try to convince the authorities that they have to do something for that credit to appear. But since those who claim are not willing to pay for the credit what that credit is worth, which would be paying deposits so that they can be intermediated in the financial sector, financial institutions are forced to lend at “subsidized” rates.
This type of dynamic results in projects that are financed at a negative real interest rate having the possibility of being projects with a negative real rate of return. This is dramatic, because it implies that this allocation of capital, far from generating economic growth, generates economic impoverishment. It can lead to the development of activities that are not profitable, which then generates interest that prevents those resources from being transferred to more profitable activities with greater social benefit.
This allocation of capital to projects with negative IRRs actually destroys capital instead of multiplying it. There is a rich literature in international economics on the concept of “impoverishing growth”[6], of which one of its main exponents is Jagdish Bhagwati. It discussed how economies with highly distorted relative prices generated investment patterns that reduced GDP at international prices. I believe that this is an issue that we have to reflect on deeply, since it is also at the root of the low productivity of our investment and the low growth of the last 5 years (among other elements, of course). Once again, I invite academic economists to delve deeper and elaborate more on these concepts.
a.3. Where we are and where we are going
It is time that we put aside these shortcuts that lead nowhere. Today it is imperative to do so. For many decades, banks faced with this scenario took the strategy of retreating their business to simply working with the transactional edge of the economy, resigning, and I say this with all its letters: resigning, their role as a link between savings and investment. This is reflected in the fact that 49% of the private sector’s deposits in pesos are on demand, and, if we also consider time deposits, 89% of the funds are less than 90 days old.
Therefore, the financial system went through the last decades basing its strategy on taking advantage of part of the inflationary tax, which allowed it to take deposits at practically zero cost, and then reinvest them through the granting of loans or in financial instruments, which return a positive return. The higher the inflation in the country, the greater the difference between that passive rate and the active rate, and therefore the greater the profitability that was appropriated.
But the drop in inflation makes it impossible for this strategy to persist. Faced with a disinflation scenario, financial institutions will have to redesign their business plans, and orient them to gain in intermediation scale, together with a reduction in their operating costs. The implicit subsidy that inflation transferred to financial institutions allowed a high level of operating costs to persist in relation to those in force in other countries of the region[7]. Therefore, as the disinflation process continues, our banks will have to rearrange their activities and objectives according to these horizons.
The BCRA considers this issue to be one of the priority axes on the agenda, and that is why we have already implemented many initiatives to reduce the operating costs of the system and stimulate its scale (the debureaucratization of branch openings, the electronic deposit of checks, the stimulation of competition among the value carriers, etc.). among other measures[8]).
We are already observing the incipient beginning of this process. As a result of the drop in the inflation rate in the second half of the year, last year was not good in terms of profitability for banks. Its results increased 24.4% in 2016. This is the lowest annual growth in the last 8 years, during which the average increase was almost 42%. This drop in profitability occurred quarter by quarter as disinflation consolidated during the year, and is a clear reflection of the challenges presented to our financial system by the context of low inflation towards which we are heading.
Note, however, the paradox of the previous government, which in its narrative presented itself as a detractor of the financial system, but at the same time, thanks to the inflation it fueled to finance itself, transferred to it really high levels of profitability in the historical comparison. In fact, during the last eight years, the annual growth in the profitability of financial institutions peaked at 66%, 58% and 50% in 2009, 2014 and 2013, respectively.
To stimulate the development of the financial system, among other measures, the BCRA introduced UVAs (“Purchasing Value Units”), units of account tied to inflation, which allow savings to be preserved in domestic currency and stimulate long-term credit. I believe that a tool of these characteristics will allow us to correct one of the worst deficits in our financial system: its very short investment horizons, both in the case of deposits and loans. The inclusion of UVAs guarantees the prevalence of positive real interest rates in the system, while reducing uncertainty regarding the real value of the intermediated funds.
The type of credit par excellence that requires a longer-term perspective is precisely mortgages. UVAs allow the real value of the capital granted to be safeguarded, so the initial installments of the loans no longer have to compensate for all the real loss of future value of said loan. This is why the demand from the public and the consequent growth of mortgage loans under this modality is so palpable, since the installments plummet to values close to those of a rental.
Today, UVA loans have been growing at a rate of about $1,000 million per month, accumulating more than $5,100 million granted since its launch in April. And the prospect is that these values will accelerate in the coming months.
A few days ago, PROCREAR loans were launched under this modality, for which for every million pesos loaned, the monthly payment is $2,500. These lines allow that, starting from a practical non-existence of mortgage credit in Argentina, with impossible access for more than 90% of the population, from now on this type of credit becomes accessible to more than 50% of the country’s households. If the purchase were for half, $500,000, the installment would be 1,250 pesos. Here we are talking about more than 80% of the population with income having access to the possibility of buying a home. We then went from not having mortgage loans to a situation where “if you have a job you can buy your house”. It is a revolutionary change for our country.
In my inauguration speech at the BCRA[9], I had raised the possibility that a loan of $750,000 would have a quota of $2,211. Today this proposal is becoming a reality, and since the word of a central banker is his most important asset, I have no problem today in reminding him of this point.
Obviously it will involve a redesign of the construction industry. In a context without equal opportunities in access to financing such as the one our country has been experiencing for years, construction focused on the high-income segment. With more widespread access to credit, real estate developers will need to target homes for lower-income families. That is where we are excited about the possibility of radically changing the housing situation in our country in a few years.
However, increasing access to credit also requires the presence of a supply of funds with longer maturities than those currently in force in the financial system, in order to avoid mismatches in the balance sheets of the entities. For this purpose, Decree 146/2017 was established, which allows banks to issue negotiable securities and/or trusts adjusted by UVA, for terms of no less than two years and related to the development of activities related to construction or real estate. This makes it possible for banks to negotiate their UVA mortgage loan portfolios in the market, and increases the sources of funding available for the granting of these loans, in the same denomination and longer term.
It should be noted that time deposits in UVAs represent an investment for the depositor that protects their savings from the erosion of inflation. Let us look at a concrete example that I have already mentioned on several occasions. A person who had invested $100 in fixed terms since the early eighties, today would have $1.5 in real terms. That is, he would have experienced an almost complete liquefaction of his initial savings. On the other hand, if you had had this new savings instrument in UVAs, let’s say, a rate of 4%, today you would have $410, at constant prices. That is, it would have quadrupled the real value of its initial capital. Notice, something that may surprise some, that buying dollars would not have been a better investment either, since if you had kept that currency since then, today it would have a real value of only $68.
That is the potential of this new savings and credit tool. This is a key element for the development of the local financial sector, mainly in relation to mortgage loans and as an incentive to return to long-term confidence in our currency.
I consider your work in disseminating these instruments to be very important. Despite the fact that these mechanisms have been shown to work in other countries for years (most notably in Chile), the concept that a capital in UVAs allows a lower interest, with installments similar to rent, and the fact that it is not a payment equivalent to “inflation plus interest”, are notions that need some initial explanation. at least until people see them working in practice and the doubts disappear. It would be interesting and very enlightening for society to deepen the study and dissemination of these issues. I hope to arouse curiosity in some of you to take up this baton and shed more light on these issues and their possible long-term implications.
b. Why we want low inflation
Let us now turn to the second impact of our task as a central bank, which has to do with reducing inflation. I want to elaborate on the fact that the drop in inflation contributes both to equal opportunities and to economic growth.
b.1. Inflation and equity
Inflation disproportionately punishes the most vulnerable sectors, taking away the possibility of accessing full equality of opportunities, and tangibly worsening the distribution of income in our society. Let us never forget this. Inflation is not an instrument of macroeconomic management, it is simply a tax, and one of the most regressive.
I have already shown this graph on several occasions, which speaks for itself:
That is why it is surprising when many of my colleagues question the benefits of the disinflation process promoted by the BCRA. As if the history of Argentina were not enough, when commenting from the profession on the BCRA’s inflation targets, which, as you know, this year are between 12% and 17% (a high number in the international comparison), many voices that are heard highlight the costs of achieving this inflation. This is truly surprising.
Even if one were to believe in the Philips curve, which the history of our country has also tired of denying, only an exorbitantly high discount rate could justify not working to lower the inflation rate as quickly as possible. This is curious, to say the least: if we were to propose to society the need to increase the real income of the lowest income decile by almost 20%, and of the second decile by 10%, I don’t think it would hear much criticism. I think they will say that it has to be done, and that it cannot wait. However, if one says, “well, that’s precisely what lowering inflation is.” That’s when a series of doubts and questions begin to be heard. Great paradox. Worthy even for a study in the area of behavioral economics.
Not to defend the fight against inflation, and I say this to my fellow economists, is to defend the regressivity of income and, as I will now turn to this issue, it is also to support a policy that threatens economic growth in the short and long term.
b.2. Inflation and growth
The relationship between inflation and growth can be addressed from the conjunctural and from a longer-term perspective.
In the current situation, we have always said that there is nothing more reactivating for Argentina than lowering inflation. If we were to say, “the most reactivating thing for Argentina is to lower taxes on the lower-income population,” I think we would not receive major objections. As I mentioned, that means precisely reducing inflation.
As if Argentine history were not enough (already in his famous work in American Economic Review, Robert Lucas[10] showed Argentina with a negative relationship between inflation and growth), we can today add last year’s data. In the second half of the year, inflation fell to a monthly average of 1.4% (18.5% annualized), while, simultaneously, economic activity came out of the recession in which it had been mired since the third quarter of 2015, showing growth in the last quarter of 0.9% according to the EMAE. And this expansion continues in the first months of this year.
This year also does not present a dilemma between disinflation and growth. In fact, given the level of collective bargaining, a drop in inflation redistributes income from companies to salaried workers, increasing real wages. Those who today criticize our goal are actually asking for it to be redistributed in the opposite direction, from workers to employers. It is difficult for us to fully understand it.
Moving on to a longer-term view, it is worth remembering that the countries that managed to lower their inflation rate below the 20% threshold in a sustained manner, doubled their average growth rate in the years following such an achievement[11].
There are many reasons why inflation damages growth: the shortening of people’s investment and planning horizons, the fall in savings levels, but there are two in particular that I would like to highlight as well, because they are also linked to its redistributive impact.
One of the most damaging effects is that inflation significantly reduces the information content of the economy’s prices. No one knows how much things are worth, and the price of different products today does not form a meaningful reference to what their price will be in the future. By not knowing how much things are worth, people stop looking “by price”, feeding a vicious circle that generates a kind of “market power” in the distribution chain, reducing the purchasing power of consumers.
Inflation then, through the variability of relative prices and the destruction of the informative content of prices, tilts the balance of the market in favor of the price makers. Since consumers do not know how much things are worth, and while we are looking for the best price, they can change, more room appears for us to accept prices higher than those that would be if inflation did not exist. This idea was synthesized in what I believe is one of the best works written on the consequences of inflation, published by Mariano Tommasi in the American Economic Review[12]. There you can read:
“Contrary to the hypothesis of “managed inflation”, which establishes the sense of causality from profit margins to higher inflation, (…) The causal relationship originates from higher inflation that affects the market structure and its performance. Price instability distances the economy from perfect competition.” (Own translation).
What Tommasi demonstrates is that price instability acts to the very detriment of competition in markets itself, consequently harming the well-being of society as a whole and deteriorating the ability of markets to allocate resources. The recovery of the price system is one of the primary advantages of lowering inflation.
A second effect of inflation, which reconnects us with the issue of the financial sector, is that it impacts its ability to grant loans efficiently. In a paper published in the Journal of Development Economics with my colleague José De Gregorio[13](1997), we argued that “(…) The ability of financial intermediaries to distinguish between heterogeneous firms shrinks as inflation rises, (…) productivity differentials between firms narrow when inflation accelerates. This effect creates incentives for riskier and less productive firms to appear to behave like high-yield firms, and can cause financial institutions to be unable to correctly differentiate between borrowers,” resulting in a less optimal allocation of lending capacity. This is also an example of how inflation corrupts the integral functioning of the economy.
c. Conclusion
In short, the conclusion I want to reach is that the costs of having high inflation are very high, both in terms of equal opportunities and also in terms of economic growth. Reducing it, as this Central Bank and the Government intends, to 5% per year by 2019, will be one of the fundamental elements that will allow a definitive productive and distributive take-off of the Argentine Republic.
It is for this reason that the Central Bank has maintained a contractionary bias in its monetary policy. In fact, leaving its reference rate unchanged at 24.75% since November last year, not moving it despite a sharp drop in inflation in December and January. As we have said recently, ensuring that the targets are met leaves no room at this time to think about a relaxation of monetary policy. Moreover, during the last few weeks, we have observed that short-term interest rates have been located near the lower limit of the monetary authority’s pass corridor, so the BCRA has begun to remove surplus liquidity in order to locate it more clearly within that corridor.
By taking this attitude, the BCRA is defending above all the most vulnerable in our economy.
I would like to conclude with a formidable aspect of the local economic discussion, which I cannot avoid the temptation to comment on in this area, and that is the little relationship that is made in the local profession between monetary policy and inflation.
For most local economists, and I think I am not exaggerating, the sharp monetary contraction of the first half of last year had nothing to do, according to this view, with the abrupt deceleration of inflation in the second half. Keep in mind that inflation in the 2nd semester was only a third of the inflation of the first semester.
As I have quoted several times, I think it is appropriate to recall what I heard from Mario Draghi a few months ago in the BIS:
“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.
(…) In this context of timidity regarding the effectiveness of monetary policy, inflation expectations were prone to become unanchored, opening the door to waves of price increases that reached double digits at that time. The result was a stage called “stagflation”, where both inflation and unemployment increased in tandem.
The policy lesson that emerged from this period was that sustainable economic growth could not be separated from price stability, and that price stability in turn depended on credible and committed monetary policy. From 1979 onwards – with Volcker taking over as chairman of the Fed – central banks converged towards this orientation and took full charge of meeting their inflationary targets. As the renewed commitment to control inflation was understood, inflation rates fell sharply, in a context of better anchoring of expectations.” [14]
Consistent with this vision, it is worth looking at the work of Martín Uribe[15] who demonstrates, through a model of intertemporal consistency, that the strategy of reducing inflation in combination with a gradual correction of the fiscal deficit, represented by a policy of exceptional liquidity absorption at the beginning of our administration, configures a policy that optimizes intertemporal social welfare.
But look at the model. An intertemporal consumer with money in its utility function, a money market, and a budget constraint for the government. I think that Martín (and I add that I don’t either) would not even think of discussing inflation without these ingredients. In this model, money is intimately related to the resulting inflation. Also in the works of Yuliy Sannikov, Enrique Moral Benito and Anusha Chari it can be clearly seen.
The fact is that all the models of the profession could not explain the phenomenon of inflation without analyzing the equilibrium in the money market. They could not explain the phenomenon of inflation without currency (we did not see barter models with inflation). However, the explanations made by the profession in Argentina about inflation omit the existence of currency. That is, they are narratives that are constructed that do not include the currency component as present in the explanation. It is in this dimension that I see the greatest benefit of this seminar.
Thus, seminars such as this one contribute to a better understanding of economic phenomena and perhaps, hopefully, they will lead the way to change direction and help us to achieve our objectives.
Thanks a lot.
[1] Olson, M. (1965): The Logic of Collective Action: Public Goods and the Theory of Groups. Harvard University Press.
[2] Acemoglu, D. and Robinson, J. (2012): Why Nations Fail: The Origins of Power, Prosperity, and Poverty. New York: Crown Business.
[3] Available here: http://www.bcra.gov.ar/Pdfs/PoliticaMonetaria/IPOM_Enero_2017.pdf (Section “Accounting of growth for Argentina 1980-2016”, p. 46).
[4] Buera, F.; Kaboski, J. y Shin, Y. (2011): “Finance and Development: A Tale of Two Sectors.” American Economic Review, 101(5), pp. 1964-2002.
[5] Eberly, J. and Alexander, L. (2016): “Investment Hollowing Out”. Presented at the 17th Annual Jacques Polak Research Conference at the IMF, November.
[6] See, for example: Bhagwati, J. (1958): “Immiserizing Growth: A Geometric Note,” The Review of Economic Studies, Vol. 25(3), June, pp. 201-205; Bhagwati, J. (1987): “Immiserizing growth”, in The New Palgrave: A Dictionary of Economics, (Eds: J. Eatwell, M. Milgate and P. Newman) Macmillan, London; and Johnson, H. (1955): “Economic Expansion and International Trade”, The Manchester School, Vol. 23(2), May, pp. 95-112..
[7] For more details on this issue, see the Financial Stability Report for the second half of 2016.
[8] See the “Measures Adopted” section on the BCRA website for a complete list of the initiatives implemented in this regard.
[9] Available here
[10] Robert Lucas, Jr. (1973): “Some International Evidence on Output-Inflation Tradeoffs”. American Economic Review, American Economic Association, vol. 63(3), pp. 326-334, June.
[11] See the section “Inflation and long-term growth” in the October 2016 Monetary Policy Report.
[12] Tommasi, M. (1994): “The Consequences of Price Instability on Search Markets: Toward Understanding the Effects of Inflation”. American Economic Review, American Economic Association, vol. 84(5), pp. 1385-96, December.
[13] De Gregorio, J. and Sturzenegger, F. (1997): “Financial markets and inflation under imperfect information”. Journal of Development Economics, vol. 54(1), pp. 149-168.
[14] Excerpt from the speech by Peter Praet, Member of the Executive Board of the European Central Bank, at the LUISS School of European Political Economy, 4 April 2016, Rome.
[15] Uribe, M. (2016): “Is the monetarist arithmetic unpleasant?”. NBER Working Paper No. 22866.
