How to defeat inflation

The government boasts of having lowered inflation from 25% per month to 4.6% per month, very high levels and the counterpart of a deep economic recession.

The Government’s diagnosis is that if there is a fiscal surplus and no money issuance, there will be no inflation. While maintaining a managed exchange rate float and the “cepo” to have an exchange rate anchor, a lesson from 2015-2019 when underestimating the exchange rate issue doubled inflation.

Beyond the President’s words, who assumes that by drying up the peso economy inflation will decrease, it is clear from the Argentine experience that inflation is not only a monetary phenomenon, but that it has multiple institutional and economic factors that cause and reproduce it. Inflation will triple worldwide in 2022, in the style of the 1970s, due to higher costs, supply shocks and problems in supply chains, in addition to monetary and fiscal reasons, as recognized by the Fed and the European Central Bank, as well as the IMF and various central banks in the developed and emerging world.

Curbing inflation that is partly due to higher costs (rates, exchange rate, rents, taxs, etc.) with a retraction of demand, does not eliminate the inflationary phenomenon and aggravates the problems of the real economy.

That is why in Argentina and around the world Stabilization Plans were made that include orthodox and heterodox tools that attack all the causes of the inflationary phenomenon.

Apart from the promise of a fiscal surplus, which remains to be seen how credible and sustainable it is, there is the commitment to not issue money, which is closely linked to the fiscal issue. It is clear that replacing monetary issue with fiscal issue via debt does not solve the country’s structural problems or improve expectations.

Regarding monetary issuance, the Government intends to stop the issuance through the two main factors of the same: 1) issuance to address the accumulation of monetary liabilities (ball of remittances before Leliq) via the exchange for Treasury debt. Operation that we analyzed last Sunday. 2) issuance for the purchase of dollars, via monetary absorption through the sale of accumulated dollars in cash with settlement.

This operation has the virtue of allowing the exchange rate gap to be arbitrated, temporarily slowing down expectations, but it does not generate an accumulation of reserves nor resolve the underlying issue: the insufficiency of external assets and much less the external restriction that is deepened by an appreciated exchange rate through greater imports.

It is clear that there is an implicit exchange rate objective. If the Government said that the issue of money to buy dollars was not inflationary, why did it do so? To stop the gap, which feeds back into the expectations of devaluation and is inflationary. They do not recognize it discursively, but they know that it is central.

Can the Government lower inflation? I think that it will be possible to reduce it to a minimum of 2% per month at the cost of maintaining the economic recession. A recession that will offset the inflationary pressure of pending tariff increases and other indexation mechanisms that will set a high floor for inflation.

In order to reduce inflation, a comprehensive stabilization plan is necessary. This plan requires some prerequisites. The first is to have an exchange rate that is not out of date, and there is unanimity among economic analysts, the market and the IMF that this exchange rate is not in equilibrium without the current restrictions. That is why the exchange rate gap is growing.

Bridging the gap is a short-term solution, but not a long-term solution. A realistic exchange rate, sufficient reserves and a sustainable dynamic of the external sector are necessary. The second factor is to end adjustments in regulated prices / to move towards “deregulation”.

The economy cannot be stabilized while relative prices are being readjusted. Not only fiscal and monetary balance is necessary, but also exchange rate stability. A key issue that generated tensions in the Austral Plan and to a lesser extent in Convertibility is that the price of internationally non-tradable services does not converge to international values ​​even with exchange rate stability and, by nature, economic openness does not solve the problem.

What is missing to achieve comprehensiveness and sustainability?

A comprehensive and consistent plan is much more than isolated measures or monetary or exchange rate tricks. It involves attacking all the causes of inflation simultaneously and consistently to generate favorable expectations that are sustainable. We will analyze three factors missing from the “anti-inflation program”

Need for a price and wage agreement

In order to achieve a reduction in non-tradable sectors, it is essential to coordinate expectations through a price and wage agreement, as in the Austral Plan or the Israeli anti-inflation plan of 1985, which was simultaneous with the Austral Plan. It is interesting that the Israeli case, which, unlike the Austral Plan, was able to be sustained, was the result of a political agreement between the two political coalitions (Labor and Likud). A comprehensive and consistent plan must be the result of agreements in order to be long-lasting.

There are also mechanisms to avoid oligopolistic or monopolistic practices, something that the Government does not do outside of controls, agreements or spasmodic regulations, contradictory to the official discourse and to some measures taken, as we saw in the case of Prepagas. Who will bell the cat? Agreements require a strong State to avoid abuses by private companies.

A credible wage and price agreement is vital to manage the convergence time until the macroeconomic situation brings inflation to the target. There is no case where a regime of high inflation or hyperinflation can be moved to very low inflation without a wage and price agreement that prevents a spiral of costs. An agreement that guarantees that supply will be adjusted to the increased demand generated by price stability that guarantees productivity and provides a distribution of income that is politically and socially sustainable.

Attacking indexing

To avoid an inflationary dynamic and linked to the above, there is no way to stop price increases if there are contracts that adjust for past inflation and reproduce future inflation. The Austral Plan and the Convertibility Plan included a discount in the first case and a prohibition of indexation in the second.

If the issue of the accumulation of past inflation in the present is not resolved, increases are generated that feed back into future increases in costs that go to prices.

Managing expectations

The sustainability of the program presupposes the above (fiscal, exchange rate, prices and wages issues, absence of price lags, halting indexation) but the key is that it is credible and sustainable. It is vital to break inflationary expectations.

This implies reasonable price levels, flexibility to accommodate cost increases, but without excesses or abuses, and resolving the issue of external sustainability, which is essential to avoid expectations of devaluation that generate price increases in a dollarized economy. In other words, sufficient reserves and a balanced external sector.

Stabilization plan

This stabilization and growth plan must move away from dogmatism, taking lessons from our history and reconciling i) consistent policies, ii) crucial external support to have foreign currency to face the initial mistrust until credibility is achieved, iii) strong political support, ideally beyond the ruling party in power, complemented with agreed institutional reforms in the medium term, iv) reconcile firmness in the initial phase to sectoral pressures, with social consensus and prioritizing the most vulnerable sectors, v) and linked to the above, sustain policies over time with reasonable flexibilities in the face of changes in external variables, but without modifying the core of the program. Situations that neither the Austral Plan nor the Primavera Plan, for example, took into account.

Of course, the global context is complex, with high inflation worldwide in recent years. While it is not possible to mechanically replicate experiences, beyond the adverse shocks suffered by past stabilization plans, their limitations, deviations and inconsistencies must be taken into account as a lesson for implementing a successful plan over time.

In the case of the Austral, beyond the drought and the fall in prices of our country’s exportable goods, there were price and wage slides, as well as pressures towards higher levels of public spending, which generated inconsistencies in the exchange rate dynamics that in turn triggered increases in prices and the exchange rate. As we know, Alfonsín’s government had a minority in the Senate and the unions were aligned with the opposition.

Convertibility was an extreme liberalization that led to an external deficit financed by debt. It was a very rigid monetary scheme, as successful in lowering inflation as it was inefficient in adapting to shocks. Thus, the plan was mortally wounded when Brazil was overvalued in 1999, given the impossibility of financing the fiscal deficit through monetary means or through the debt market and also of not being able to compensate the growing current account deficit with commercial and/or financial foreign currency inflows.

The collapse of convertibility due to a fiscal deficit, but also an external deficit that cannot be financed and with a lag in exchange rates, clearly demonstrates that inflation cannot be sustained if the real economy collapses and there is hyper-unemployment. An economic and social imbalance makes low and stable inflation unviable. Injustice and unviability go hand in hand, as Keynes pointed out.

If the President does not like Keynes to see the impact of the “peso drought” he can see an analogy in the story of the Golem. The wife of the Prague rabbi who sent her husband to fetch water from the river and did so with such zeal that he not only dried up the river but flooded the synagogue.

The Lavagna plan of 2002-2003 had years of very important growth, which after 2010 suffered the reappearance of external restrictions that caused a strong recovery in imports, including energy, after 2011, a fall in the value of exports since 2012, which worsened in 2014, and then the restrictions on financing generated by the conflict with vulture funds, which forced the adoption of exchange restrictions, generating a large exchange gap that reached a maximum of 90% in September 2014 and then fell to 40% by the end of 2015.

It can be said that there is a general consensus that, in the short term, in order to regain some stability, the first thing to do is to restore the level of reserves. Then, more structural measures must be taken to address the exchange rate imbalance and inflationary inertia.

In short, inflation can be reduced in a deep and lasting way if a synthesis is achieved that gathers the fruits of collective learning, considers our economic structure and reality, and is successful in changing the expectations of the social collective within the framework of an agreement that reconciles the multiple challenges.

Due to the very characteristics of Argentine history, a stabilization plan must be accompanied by measures that ensure its viability over time and that generate a) a productive profile that guarantees growth and stability of the external sector 2) a path to recover the purchasing power – already badly hit – of the population (or at least stop its deterioration). What is resolved at the macro level will be broken down into the social situation 3) a political agreement that guarantees economic and social sustainability.