Inside the mind of Argentina’s central bank
Argentina’s idiosyncratic approach to monetary policy and inflation control is unlikely to be effective.
Who needs a nominal anchor? Although most central banks use a policy rate to anchor inflation that weighs expected inflation and GDP dynamics, the Argentine central bank (BCRA) is now following a fully passive approach, where monetary policy accommodates to money demand. It is now the BCRA’s policy to accommodate monetary expansion with price expectations, private-sector credit, exchange rate policy and – fundamentally – the treasury’s funding gap. According to analysts such as Alejo Costa, head strategist at Puente, an independent investment bank in Buenos Aires, this passive (or endogenous, in BCRA’s words) approach to monetary policy means that directionality goes from current prices and output to money supply and short-term ‘policy’ rates.
Orthodox inflation targeting, where the policy rate is based on expected inflation and economic activity, anchoring current inflation and affecting output, has been eschewed. In the BCRA’s mindset, inflation is driven mainly by supply factors, oligopoly power and external shocks; in the BCRA’s view the use of interest rates or the monetary base as nominal anchors are ineffective and only lead to an unnecessary contraction in output.
The directionality from money demand to money supply and policy rates means that economic activity, the velocity of circulation and the current price level determine monetary policy. Argentina’s government has targeted those three variables to control inflation, as opposed to using interest rates or money supply. Fiscal policy has been used to tame interest rates and boost public investment. Different restrictions have been imposed to contain money demand and the velocity of circulation, and tariffs on public services have been rigidly controlled. In February, a price freeze on consumer goods (mostly affecting the food and beverage industries) was introduced with the goal of containing salary negotiations and, thereby, inflation for the remainder of the year (or at least until October, when mid-term elections take place).
Inflation, although still high, seemed to have been partly tamed, at least in the short term. National statistics office Indec reported that CPI inflation was at 0.5% month on month in February, down from 1.1% in January – and, although the agency’s figures are widely discredited, the downward direction in the February figure might well be accurate. However, the longer-term success of the policy remains far from certain; the full effects will be seen only once the price freeze is over. It is noteworthy that 12-month inflation expectations, as surveyed by University Torcuato Di Tella’s think-tank, have not been anchored; they remain at 30%.
For the government, reducing inflation from its current level comes down to a huge task of reaching a credible equilibrium where most costs, non-tradable good prices, wages, imported-good prices – and hence the exchange rate – are all simultaneously kept under control. Among these, current salary negotiations will be a key factor. Average wage increments above the rate of inflation will accelerate future inflation and put additional pressure on the exchange rate. Current negotiations have established increments at around 25%.
Following BCRA’s own logic, fiscal policy should also play a part to give Argentina’s economic strategy any chance of success. Any nominal equilibrium where funding needs from the central bank are not tamed will inevitably succumb to inflationary monetary expansion. Considering the outcome of wage negotiations and fiscal projections it is hard to envisage anything but a (very) temporary reduction in inflation.
Argentina is evolving its own distinctive approach to monetary policy and controlling inflation, but it is unlikely to be an effective one.