The pragmatism of Mexico's Agustín Carstens

The IMF’s loss has been Mexico’s gain. Euromoney’s Central Bank Governor of the Year, Agustín Carstens, continues to keep a steady hand on the economy’s tiller, his orthodoxy mixed with pragmatism that is helping to propel the country forward. He remains outspoken about the need for reform at the IMF.

In early June 2011, shortly after the governor of Mexico’s central bank had officially entered the contest to succeed Dominique Strauss-Kahn as the managing director of the IMF, Kevin Gallagher, professor at Boston University and co-director of the Global Economic Governance Initiative, published an article entitled "Why Agustín Carstens should not be the next head of the IMF".

Gallagher (a professor of international relations, rather than economics) welcomed an emerging markets candidate, but argued forcefully against Carstens’ candidacy on his economic record, which "epitomizes what is wrong with global finance", and he argued that Carstens had "not been able to learn from the [2007/08] crisis and has been stuck to outdated thinking ... [holding] Mexico to tight inflation targeting and shunned capital controls".

Gallagher was writing as liquidity driven by quantitative easing was flooding into emerging markets and countries such as Brazil were frantically constructing sandbags of capital controls. Central banks in advanced economies and emerging markets had moved to new macro-prudential monetary policies, either to promote domestic growth or manage the fallout from externalities that others’ zero-lower-bound strategies were having on their own economies. The article went on to label Carstens a "Chicago Boy", given his training at the economics department of the University of Chicago, which Gallagher characterized as a promoter of "discredited theories of rational expectations and efficient markets".

It’s not a view shared by many. And bankers in Mexico would argue that the IMF’s loss was their country’s gain.

Two years later, having lost out on the IMF job to France’s candidate, Christine Lagarde, Carstens is still governor of the Banco de México – presiding over one of the most open economies in the world – certainly among emerging nations. With the Brics slowing, Mexico’s future looks bright. Although economists have been shaving 2013 forecasts for a plethora of largely one-off, short-term factors very few were lowering their growth projections for 2014, and the proposed energy reforms have many forecasting long-term trend growth of between 5% and 6%.

Inflation is low and expectations are anchored; FX depreciation over the past few months has been lower than the peso’s peer group as money flowed out of emerging markets; fiscal reform is planned; and Mexico is attracting inward investment – both foreign direct investment and capital flows – at strong levels. All this contrasts starkly with some other areas of the emerging world.

Facing a changing global macroeconomic environment, this year some emerging market central banks have been trying to convince markets that inflation-targeting is really their primary function (not an easy job to do quickly) to re-anchor expectations of inflation. In the developed world, the belief in the newly adopted theories of forward guidance is being shaken in practice, especially since September’s Federal Reserve decision not to begin tapering quantitative easing has highlighted the difficulties in weighting linguistic nuances to such an extent.

So, does Carstens feel that the argument about central banking policy has swung back to orthodox, inflation-targeting? "It’s a good question," he says. "My beliefs in terms of what the role of the central bank should be are deeply anchored – not so much by orthodoxy but by having been involved for over 30 years, in different shapes and forms, with central banking. I started my career here, I had 10 years outside the bank [Carstens was deputy director of the IMF between 2003 and 2006 and Mexico’s finance minister between 2007 and 2010] and I have seen policy from different angles. And I think the best way that the central bank can help any economy is by keeping inflation under control."

Carstens is also keen to nuance Euromoney’s depiction that he is a pure economic rationalist, for example by expounding his stance on capital controls. He says: "We have been facing unprecedented times in the last three of four years where there have been massive capital flows coming into the emerging markets – and more recently a reversal – and I think that framed as part of macro-prudential policies [and] under [certain] circumstances, capital controls could be an adequate policy to follow. Given the capacity to absorb capital in some emerging markets some of the inflows can be very distortionary and [capital controls] to prevent those distortions are adequate." This approach puts Carstens, theoretically at least, in line with the IMF’s measured but controversial backing of capital controls in 2011.

However, one wonders what exceptional conditions would lead Carstens to introduce them. He says Mexico has not been close to using capital controls since the 1980s ("we didn’t have a very good experience"), and he believes the experiences of some of his colleague countries show that "oftentimes capital controls or macro-prudential policies can themselves introduce distortions to the market and subtract from clarity and I think it has worked for us to have a stand-off approach". Carstens also uses discussion about the Chicago School to cite Ronald Coase, a Nobel prize-winning member of that particular establishment, whose eponymous theorem contends (summarized crudely) that regulatory responses to externalities are ineffective, certainly less so than the free market.