The Governor of the BCRA, Federico Sturzenegger, participated in the panel “Monetary and Economic Perspectives” of the 9th Forum on Economics and Business organized by Fundación Libertad.
We present here the full speech:
Thank you for the inviting me to speak today. It is always a pleasure to participate in these valuable spaces for discussion and critical thought in which we share the ideal of freedom.
Argentina has been living with some fear of freedom for a long time. There is a debate that is as old as human history, a debate between those who believe that freedom must be defended—as it is one of the essential values that allows us to develop as human beings and a key instrument of economic progress—and those who, on the contrary, believe that freedom is merely the validation of an unequal arena that only benefits the powerful to the detriment of the weakest. In this second worldview, authoritarian or totalitarian practices are justified, finding various excuses to trample on the realm of individual freedom.
This debate has been constant in the social and political life of all humanity, and it would be pretentious of me to review it, but allow me to humbly offer some personal thoughts that may be useful.
Our Constitution is wise on this point, and it is worth re-reading its Section 19, which states:
“The private actions of men that in no way offend public order and morality, or harm a third party, are reserved to God and are exempt from the authority of magistrates. No inhabitant of the Nation shall be compelled to do what the law does not mandate, or prevented from doing what the law does not prohibit.”
However, we often violate this constitutional mandate in our laws and regulations (although each case will not be exempt from controversy and must be analyzed separately) because we have gradually pushed the line that divides private actions from public ones.
Let me give you a very simple example to illustrate this regarding an activity that I have to regulate from the BCRA: the opening of bank branches. At the beginning of our administration, there was a regulatory framework with a large number of conditions, obligations, and requirements for a financial institution to establish a branch. Aside from the fact that I never understood why the State would like to prevent a branch from opening, the truth is that establishing a bank branch is a legitimate business, it does not offend public order, it does not violate public morality, and it does not harm a third party. Why should the State impose conditions on an inhabitant of our Republic to undertake this business? And, on the other hand, why do we so passively accept that the State should interfere in this decision? (It is not necessary to clarify that these restrictions and conditions no longer exist and, consequently, the establishment of new branches has flourished. To be exact, 86 branches were established in 2016 and, in the first quarter of this year, 69 additional ones have been opened—more than the 62 branches which opened throughout 2015—and this took place without any reported damages or offenses resulting from this expansion.)
But apart from this defense of individual freedom per se, as an economist, I have great respect for freedom as the foundation of the social world, and as a vehicle for individual and collective progress. Of course, this is supported by the evidence of free societies, which are much richer and more prosperous than totalitarian ones.
In this regard, it is worth reviewing some of the arguments of the well-known economist and Nobel Prize winner Amartya Sen in his recent book Development as Freedom. There, Sen intimately associates the concept of development with that of freedom. In his view, people interact in various ways: when talking, criticizing, or chatting on social media. And, as Sen says, an essential part of development should take place in an environment full of freedom. Unfortunately, there are times when governments do not like people saying, reading, or seeing certain things. And then they use direct censorship, as Nicolás Maduro’s government does, by closing opposition media or blocking social media, or indirect censorship, by buying media or paying journalists to convey a certain message. But, as we know, it is very difficult to prevent people from saying, reading or seeing what they actually want to say, read, or see. I remember that, when I attended secondary school at Colegio Nacional de La Plata between 1978 and 1983, the librarian would sneak me a copy of The Revolt of the Masses by Ortega y Gasset under the counter, and would mischievously say, “Look, this is banned, don’t lose it.” But off I would go to read the book, not only freely but also happily.
Similarly, says Sen, just as people talk, criticize, and chat—and this freedom to talk, criticize, and chat is an essential part of freedom and development—people also make transactions: they buy, sell, negotiate, offer services, or demand them. And being able to do this in a context of freedom is also, he says, key in the agenda of freedom and development for any society. This freedom is what makes each individual be focused on offering their fellow citizens something that is useful to them, interests them, or even motivates them to buy it. These incentives boost progress in society. Sen concludes by saying that before assessing whether markets work well or not, whether they serve to stimulate growth or not, there is a dimension of individual freedom that cannot be compromised. Without freedom, no development is possible, precisely because freedom is an essential component of progress and the society we want to build.
In Argentina, Fundación Libertad is one of the institutions that has best and most persistently argued these ideas. This does not mean that there are never reasons to justify state intervention; for example, an uncompetitive market needs smart interventions to promote competition. However, if we do not understand well why intervention is needed, we enter a process of overregulation that can restrict the margins of freedom with no need (and create incentives for corruption and privileges).
Perhaps a terrible experience we underwent was the so-called foreign exchange clamp, which absorbed the energies of our society in vain for four long years and, in turn, gave rise to inequities, corruption, and privileges to a great extent. It led the State—and the BCRA played an important part—to produce a network of regulations, obstacles, summary proceedings, and harassment of which there is nothing to be proud. One of the most cherished times of our administration was that early morning of December 17, when we decided to sweep away all that network in one fell swoop. We decided to restore the rule of freedom so that Argentines could have the power to choose the currency they preferred, make transactions as they wished, and save as they wanted.
Sorry for this long introduction, but I found it appropriate for this invitation with which Fundación Libertad has honored me.
Therefore, I would like to talk to you today about the relationship between inflation and freedom, or rather, about how the high inflation rate in our country has been a major hindrance to achieving both freedom and development. That is why we, at the BCRA, are so passionate about our fight against this scourge, and we are certain to succeed.
To begin with, I will present a brief overview of how we see the current and expected inflation, and then I will move on to the main topic: what changes will take place in the daily lives of Argentines as we progress towards consolidating the disinflation process? You will notice that many things we consider common today will cease to be so as we move towards the 5% annual inflation target expected for 2019.
Once we overcame the most difficult three months in terms of inflation (February, March, and April), in May, the price trend resumed the downward path it had shown in the second half of the previous year, with a 1.3% monthly change, resulting in a 24% y.o.y. inflation rate. This value represents a sharp reduction compared to the levels exhibited at the end of last year. However, it will continue to decrease even more in the coming months, and will be around 21%-22% annually in July. Those will be the lowest inflation levels since 2009.
At this stage, we must consolidate this process, until Argentina finally succeeds in achieving figures similar to those of the region by 2019. The process of disinflation has also occurred more steeply in the wholesale price segment. In May, the year-on-year change of wholesale prices stood at 15.3%.
After a sharp drop in inflation levels in the second half of last year, we gradually eased monetary policy in line with that downward path. This process continued until February this year, when we realized that the easing had perhaps been excessive in hindsight, as evidenced by the increase in inflation levels during the February-April quarter, which forced us to make corrections in the subsequent months.
Fortunately, we see from the dynamics described that the monetary policy measures we have been taking are paying off. Since early March, we have been tightening monetary policy to ensure the disinflation process. In fact, since then, we have withdrawn excess liquidity from the market, making the shortest-term LEBAC rate rise by 450 basis points and we raised the benchmark rate by 150 points in April. These actions allowed us to frame the evolution of prices to the levels evidenced in November, December, and January, before the regulated prices correction carried out in recent months.
Looking ahead, the economic analysts surveyed for the BCRA’s Market Expectations Survey (REM) expect inflation for the next 12 months to be at 17.4%, and anticipate that in 2018 it will be 15% annually.
As I mentioned, we will probably reach an annual inflation rate somewhat lower than 22% in July, giving us five months to reach the 12%-17% range. By the end of this year, it is essential to reach such monthly inflation levels as are compatible with the inflation target for next year. To this end, the BCRA seeks to ensure an appropriate monetary policy bias to consolidate the disinflation process and continue on this downward path.
This is where we are today. Now, what changes in our daily lives will result from achieving a stable macroeconomy with low inflation?
A low inflation context will extend the horizons of investment and savings in Argentina. Reducing the nominal uncertainty caused by inflation will allow for better long-term planning, making those investment projects that require a longer maturation process less risky; therefore, there will be more incentives to put them into practice. Low inflation will drive genuine investment and will be a stimulus for realizing projects that seemed unthinkable in high nominal volatility contexts.
The same applies to savings. We will be able to think about long-term investments in pesos without fearing that the value of the currency will be eroded. The rise in savings in domestic currency will boost the development of the local financial system. There will be more deposits, that is, more raw material for the much-needed increase in credit.
In this way, the financial system will finally become a true vehicle between savings and investment, thus democratizing access to capital. In an economy without generous credit, the growth of companies is slower, good ideas take longer to be implemented, projects tend to be chosen on a smaller scale and at shorter terms.
This happens because only those who already have resources can invest in a context of scarce credit. On the other hand, those who have good ideas and profitable projects but do not have the means to access the necessary financing cannot carry them out, or can only do so on a smaller scale and more slowly. A country without a financial sector is a country without equal opportunities. A country without equal opportunities is a country without real freedom, and a country without freedom, as Sen would say, is a country that will never develop.
Therefore, by promoting the development of credit, low inflation becomes a powerful driver for equal opportunities. We need a country where access to capital is available to everyone, not just to those who already have it. An example of these benefits can be seen in advance with the launch of credit facilities in units of purchasing power (unidad de valor adquisitivo, UVA). Conceptually, these loans can be thought of as being granted in a currency without inflation, so the interest paid is virtually low. A UVA mortgage loan with a 3.5% APR, as offered by Banco Nación, over thirty years (with an average amortization of 3.33% per year), implies a payment of about 5% of the property’s value each year. As you can conclude, it is very similar to what is paid for rent.
In other words, the availability of credit at reasonable rates makes housing accessible to the whole population. As the supply of housing adjusts to the new demand, it will be possible to achieve a country without a housing deficit. There are indeed benefits to reducing inflation, as we know that an increase in the number of homeowners has very positive effects on many aspects: children’s education level, fertility, savings and security levels, among others. A country of homeowners will be a different country, but this is only possible if we lower inflation.1
Additionally, an inflation targeting regime defines the target for the movement of the overall prices in the economy and thus increasingly allows us to better differentiate between shocks or events that affect the prices of all goods at the same time from those changes or events that actually affect the demand or supply of a particular sector. This will enable the price system to work much better. We will know which relative price goes up and which one goes down; today, those signals are vague or less clear.
This is closely related to the fact that, in contexts of low inflation, the much-discussed pass-through of the economy is limited. That is, the relationship between the exchange rate and other prices begins to lose strength once price volatility decreases, and agents are more capable of detecting when an event that makes the exchange rate move is not correlated with what happens at an aggregate level or in the monetary market.
In summary, nominal exchange rate movements become less traumatic for the entire economic structure, allowing the real exchange rate to respond better to fluctuations of different types.
We can review a couple of real experiences that show that, by implementing a floating exchange rate scheme with controlled inflation, the relationship between the exchange rate and the general price level loses significance. For example, in the case of Mexico, the exchange rate/inflation ratio has amounted to 80% since 1970. However, if we only analyze the last 15 years, this figure drops to 3%. In the case of Chile, the decrease recorded is also significant, going from 92% to 28%. In Peru, such correlation plummeted from 88% to 20%. When countries use their monetary policy to keep inflation under control, prices stabilize around the proposed target. This allows the real exchange rate of economies to adjust to the different situations they have to face.2
That is why it is essential to have a floating exchange rate scheme that provides our economy with enough flexibility to respond to unfavorable external events. Imagine what would have happened with the events in Brazil a few weeks ago if our exchange rate had not been able to respond to the Brazilian real depreciating by 5%, 6%, or 7% in real terms. The floating exchange rate helped us better navigate not only this event but also the global shocks caused by Brexit and the election of President Trump last year, without major upheavals. In fact, the economic growth observed in the third quarter of 2016 rose to 0.5% in the fourth quarter; it accelerated to about 0.7% in the first quarter of 2017 and once again to nearly 1% in the second quarter of 2017, according to recent estimates by the Ministry of Economy. This means that the economy could avoid external shocks without affecting its domestic recovery dynamics. So this is the use of the floating exchange rate.
At this point, I would like to remind you, especially because I imagine there are many agricultural producers here, that the best strategy you can take to reduce the uncertainty associated with exchange rate volatility is to use hedging strategies in the futures market. All companies whose cash flow is exposed to the exchange rate could thereby limit the undesirable volatility in pesos associated with exchange rate flexibility. Moreover, given that the expected devaluation in the futures market is arbitraged with the interest rate in pesos,3 and in view of the fact that the BCRA will seek to guarantee a positive real interest rate, hedging in the futures market may imply an additional positive real return for the business’s cash flow. This is to be considered. I hope that little by little you will be encouraged to venture into hedging in these markets.
Back to the main issue, a context of greater price stability also allows citizens to know the cost of things better. Inflation causes a marked rise in relative price changes, thereby destroying their informational component. This is not only because, as I mentioned before, we don’t know how a price moves in relation to the general level, but also because prices themselves become more volatile among them. As a result, nobody knows the true cost of anything. This undermines the disciplining power on price setters derived from competition, giving them more room to increase margins above costs. A market with inflation improves the bargaining power of sellers, allowing them to charge higher prices. Consumers do not even realize this, which significantly reduces their real wages.
There is an excellent paper by Mariano Tommasi4 that examines this phenomenon. The most interesting thing is that he concludes that “contrary to the ‘administered inflation’ hypothesis that establishes causality from markups to higher inflation, (…) the causal relationship […] originates in higher inflation that affects market structure and performance. Price instability moves the economy away from perfect competition.” Therefore, lowering inflation is equivalent to stimulating competition, which will allow for a reduction in margins and, hence, provide greater well-being for consumers.
Back to the relationship between inflation and freedom, what I am saying is that inflation destroys the information provided by prices, and a society with less information is a society with less freedom. Inflation is to economic information what censorship and media manipulation are to political information.
The fight against inflation will also pay off in terms of economic growth. Our studies at the BCRA have shown that 85% of the countries that managed to sustainably reduce their inflation below a 20% annual threshold virtually doubled their average economic growth rate during the decade following that achievement.5
Additionally, we analyzed 87 episodes from other countries where the inflation rate dropped from over 30% annually to below 20% within a year, and we found that in 93% of those cases, GDP growth was positive during the year of significant disinflation.6 Furthermore, the economic growth rate was, on average, 2 percentage points higher than the previous year, considering the whole sample. In other words, the benefits of reducing inflation are not only long-term but also immediate, and Argentina will join this group of successful experiences this year.
To summarize everything in one idea, today I wanted to convey that achieving a stable macroeconomy with low inflation will allow us to enjoy a true cultural change in Argentina. Until now, the severe economic cycles and chronic inflation we have suffered throughout our history have made it very difficult to understand to what extent the successes or failures in our businesses and lives have been the result of macroeconomic factors or our own decisions. A lifetime of savings cut short by a macroeconomic episode changes the very conceptualization of life itself, weakening the perception of the value of work and effort.
Low inflation and a sustained healthy macroeconomy will allow Argentines to stop worrying about the current and future macroeconomy, and to start focusing all our energy on achieving success in our personal projects and ventures.
This stable macroeconomic context, without the distortions and noise that high inflation implies, will enable this strong and positive idiosyncratic change for all Argentines. We will finally be able to focus our efforts on our projects without having to keep an eye on or worry about potential macroeconomic threats on the horizon. This will lead us to the ideal state referred to by Spanish writer Javier Cercas when he said: “Passion and fun should come from private life, not from public life. From love, from books. When you bring passions into public life, problems arise.”
And as Alejandro Rozitchner says: “The most valuable thing is for a person to want something. Enthusiasm and the desire to live are more important than critical thinking and objectivity. And we must train in this dormant power that we crush with the habit of complaint, discontent, and dissatisfaction.”
This habit of complaint, discontent, and dissatisfaction has been driven by the instability caused by inflation in our country. The time has come to deactivate it.
When, in a few years’ time, we have reached a 5% annual inflation rate and have shed all these burdens, it will obviously no longer be so interesting to come one evening to listen to the Governor of the BCRA, as you will be much busier and more interested in your private lives and ventures. For us, it will mean that we have fulfilled our task. Thank you.
1 Schargrodsky, E. and Galiani, S. (2010): “Property Rights for the Poor: Effects of Land Titling,” Journal of Public Economics, Vol. 94 (9-10), pp. 700-729.
2 See the Monetary Policy Report, May 2016 (Exhibit 3, El traspaso del tipo de cambio en América Latina: lecciones de la experiencia reciente (Exchange Rate Pass-Through in Latin America: Lessons from Recent Experience), pp. 30-31).
3 For further references on this topic, see ¿Existe bicicleta financiera en Argentina? (Is There Carry Trade in Argentina?), published on the BCRA’s blog “Ideas de Peso” on May 8, 2017.
4 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.
5 For further details, see Exhibit 1, Inflación y crecimiento de largo plazo (Inflation and Long-Term Growth) in the Monetary Policy Report – October 2016 (pp. 34-37).
6 Desinflación y crecimiento (Disinflation and Growth), published on the BCRA’s blog “Ideas de Peso” on April 20, 2017.
