Federico Sturzenegger at the Latin American Economic Research Foundation

Federico Sturzenegger, Governor of the Central Bank of Argentina, participated in the Monetary Policy, Inflation and Growth panel, on Thursday, September 29, in the framework of the Annual Conference organized by the Latin American Economic Research Foundation (Fundación de Investigaciones Económicas Latinoamericanas, FIEL).

Below you will find the full speech:

Good afternoon. Thank you very much for your kind invitation. It is a great pleasure for me to be here once again and partake in this meeting with so many friends and colleagues.

General opinion seems to be that countries can be grouped into those looking back into their history or those ready to envisage their future. I personally think that Argentina has spent too much time remembering. It is time now to change the focus and start envisioning the destiny of our country.

And that is what I want you to do right now; I invite you to conjure up the picture of an Argentina without inflation.

It is widely known that substantial progress has been made in fighting inflation in recent months. For the sake of argument, let us take the evolution of the CPI for the City of Buenos Aires where numbers speak for themselves: 6% in April (as a result of increases in utility bills which have been frozen for more than a decade), fell to 5% in May, 3% in June, 2% in July and 0.9% in August (in fact, the August figure was -0.8%, which can be explained by a reversal in the price of gas, but as the latter will probably change again in the coming months, I consider it appropriate to disregard these effects for the time being).

However, this progress does not mean that the battle has been won. In order to achieve a low inflation rate of 5% for 2019, we should actually be aware that the battle against inflation has just begun.

This afternoon I would like to draw your attention to two key issues related to the fight against inflation.

First of all, I would like to discuss why it is important to lower inflation—and we will see that the answer to this question can be split in two aspects. On the one hand, the positive impact on the reduction of inflation over economic growth; and, on the other, the fact that a drop in inflation is vital to reduce the levels of inequality existing in Argentina’s income distribution. Inflation tax is not only the most distorting and damaging tax, but also the most unfair and regressive one (as Lenin said: “the best way to destroy the capitalist system was to debauch the currency”).

And lastly, I would like to analyze whether lowering inflation entails any costs, and which role do these potential costs, if any, play over time in terms of the benefits society derives from price stability.

Before delving into the analysis, let me advance the answer to this particular question. To begin with, I would like to quote Borges's famous story:

“I have noticed that in spite of religion, …Jews, Christians and Muslims all profess belief in immortality, but the veneration paid to the first century of life is proof that they truly believed only in those hundred years, for they destine all the rest, throughout eternity, to rewarding or punishing what one did when alive.”

This analogy, leaving philosophic differences aside (forgive me Borges), may be applied to the challenge of reducing inflation. If we only believed in the present, or if we were unable to see a horizon beyond a couple of quarters, we would commit the future, the life quality of our children, grandchildren, and great-grandchildren by giving up the fight against inflation.

Let us now deal with the first question. Why is it important to have a low inflation rate, like in the rest of the world? To answer this question I would like to go over a couple of stories.

The first one is that of the State of Israel which, since its creation in 1948, has undergone three distinct phases of development. Until 1970, it grew at quite a high pace. We may refer to that time as the colonizing period, where everything was achieved out of commitment, effort, asceticism and hope.

Since 1970 Israel has uninterruptedly experienced inflation rates of more than two digits over the following two decades. The worst years being those of the first half of

Período 1944-1974

Período 1975-2015

You will see that dot concentrations are not meaningful, and the slope of the curve tends to be negative at times (which would imply a Phillips Curve with a positive slope). We could say that the years of lower growth in Argentina were not accompanied by low inflation and vice versa. The graph seemingly shows that the years of higher inflation entail the worst economic performance. While the Phillips curve may make sense in economies with a history of stability, like developed countries, it is naturally not relevant in the Argentine context. However, the graph shows that this situation may be exactly the other way around. It is the decline in inflation that is associated with recovery and economic growth. Let us put that argument aside and move on to another line of thought that is frequently shared, especially by those who challenge the 12%-17% inflation target for the coming year. According to the latter, Argentina suffers from a strong “inflationary inertia”. That is to say, a process of inflation caused by factors beyond the money market, such as expectations of rebel inflation or wage negotiations, which entail backwardness and, consequently, cause the inflationary process to continue rather than to halt. Thus, the famous “inflationary inertia” has been at the core of many debates on inflation in Argentina. During the 1980s, inflationary inertia implied that past inflation was a major determinant of subsequent inflation, so the inflationary process persisted, regardless of the monetary policy followed. At that time, there was a real “contractual inertia”. That is to say, most of the contracts were legally adjusted in terms of past inflation, which made any disinflation process very complex. Fortunately, we’ve learned the lesson, and since the introduction of the Convertibility Plan, this type of adjustment no longer exists in Argentina, so we do not have to deal with this phenomenon at the present time. In fact, Argentina stuck to this idea to such an extent that the previous administration detached from indexation, and prices soared tenfold. It is worth mentioning that many countries that underwent disinflation in the 1980s and 1990s had to deal with this type of contractual adjustment in prices. Sometimes people ask me why our disinflation process will take four years when Colombia took many more years. But it cannot be ignored that Colombia was forced by law to adjust their prices based on past inflation, generating instability with strong deviations of relative prices from their equilibrium values during the disinflation process. In fact, the potential “inflationary inertia” mentioned by analysts today could be explained by analyzing agents’ expectations, just as explained by the Barro-Gordon model . According to this model, if a Central Bank indulges in short-term commitments, then this temptation may be forecast by such agents as create expectations accordingly. Hence, inflation expectations should be high enough to dissuade a Central Bank from any expansive attempts, or, in other words, inflation with stagnation. At this juncture, the relevance of an Inflation Target Regime comes into play, particularly in order to break with this type of inertia, and to contribute towards the disinflation process. Within this framework such regime requires an independent Central Bank, and long-term targets which should not be deviated by short-term shortcuts. Once a Central Bank has gained credibility for the achievement of its long-term targets, it will be able to align agents’ expectations with future inflation targets. The Inflation Target Regime is the institutional scheme that allows breaking the type of inflationary inertia described in the Barro-Gordon model, the only one present in Argentina today. We could say that the BCRA has been successful in aligning expectations. The latest Market Expectations Survey (“Relevamiento de Expectativas de Mercado”, REM) shows that analysts’ expectations are quite in line with the BCRA’s targets for this year, and even not far from the target for the coming year. Therefore, we consider that the Inflation Target Regime is an effective tool to align agent’s expectations and put an end to the inertia as under the Barro-Gordon model. As published in the latest REM, carried out at the end of August, analysts expect a core inflation of 1.6 %, 1.5% and 1.5% in October, November and December, respectively—by setting aside the expected index volatility arising from rate changes (deflationary in August and September), and adding the expected inflation in the subsequent months. This implies that the Central Bank’s inflation target (of 1.5% or less per month for the last quarter, generally speaking) is about to be utterly reliable for the remainder of 2016. Core inflation’s expectations for next year stand at 19.8% and 17.9%. Since the target announced by the Central Bank is between 12% and 17% for 2017, we would still be facing a “credibility gap” of virtually 3 percentage points in terms of the 17% upper limit. The Central Bank has already been adopting monetary policy measures to eliminate that gap. In short, the Central Bank understands how important it is for our country to defeat inflation once and for all. We are called to look beyond the current scenario and bear in mind that staying halfway, with moderate inflation, is hardly the way ahead; we need to keep down inflation below 5% per year. It is a must to achieve such a target so that our country may fully develop with social equity. The battle against inflation has just begun. To recap, the Central Bank has all the necessary tools at hand and is carrying out its mission in a context of great independence. We do not appeal to voluntarism. Rather we merely release information about our next steps. Hence, predictability on our part together with a free background for you to adopt informed decisions is exactly what will drive Argentina out of inflation. Argentina will ultimately be a country marked by stability, growth and social justice.”

Click here to download the speech in pdf format

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September 29th, 2016

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