Versión Español
EspañolA major goal of President Mauricio Macri is to reduce inflation in Argentina. He has entrusted this mission to the central bank, which has been conducting a solid monetary policy.
This administration has understood that inflation is a purely monetary phenomenon, and for that reason, it has decided to drastically reduce the expansion of money supply.
By the end of the previous Cristina Kirchner administration, the money supply grew at approximately 40 percent. It currently stands at around 20 percent. This contractionary policy is what will allow Argentina to begin curbing in 2017 its high annual inflation rate (around 40 percent).
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The central bank’s strategy also includes reasonable monetary policy rate following inflationary expectations. It is worth noting that it is the market, not the central bank, that should establish interest rates. Policymakers are much more likely to make a mistake. Nevertheless, they are trying to use market expectations as a guide.
But Macri’s strategy to tackle inflation won’t be successful if he doesn’t address the true root of the problem.
Inflation in Argentina is high because over the past years the government strongly expanded the money supply. The money-printing binge came after many years of fiscal deficits due to high government spending.
The origin of Argentina’s inflation problem lies in its addiction to government spending. It is no coincidence that over the last 12 years, public spending in Argentina has ballooned from 30 to 46 percent of GDP — a frightening figure.
Since the tax burden is also high in Argentina, it is unfeasible to increase taxes to reduce the deficit. So politicians resorted to money printing, which resulted in higher inflation.
In other words, the Macri administration has inherited high inflation as a consequence of lousy monetary policy. And while the central bank may be doing a good job, the risk of failure in the long term cannot be ruled out because it is ignoring the deficit-spending dynamics I have just explained.
The Argentinean government has still not sent clear signs that it will reduce fiscal deficit, effectively putting the cart before the horses. If Macri doesn’t address it, his whole effort on monetary policy could be in vain.
Fiscal deficits will persist as long as public spending continues to be excessive. Given that Macri’s stated goal is to reduce inflation, he has chosen to finance deficits through debt. But sooner or later, that debt must be paid off.
In short, what has changed with the new administration is just how public spending is financed. Instead of filling the gap with new money and inflation like Kirchner, Macri does so through bonds, a strategy that is already raising red flags of alert.
Argentina’s debt in bonds equals to 102 percent of the monetary base. That is, the amount of debt is roughly the amount of money circulating in the economy.
If Argentina had to service all its bonds, it would have to double its monetary base. Of course it’s an extreme example, but it just aims to show how large the debt is and the danger of a “snowball” situation.
What can we expect inflation in Argentina to look like during the remaining three years of Macri’s administration? In 2017, the annual inflation rate will probably slow down and remain around 20 percent.
The halving of inflation is an important achievement. The main cause of this decline is the aforementioned monetary contraction, and its impact will be seen next year as these measures usually have a delay of 12 to 18 months.
However, elections are scheduled for 2017 , so the government will hardly cut back public spending. And again, this means it must be financed somehow.
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Since issuing more debt could be met with opposition, there is a risk of allowing the central bank to finance government spending, jeopardizing the 2018/2019 inflation targets. To avoid this, the long-awaited foreign investment would have to arrive, but they are still very timid.
In sum, Argentina is conducting good monetary policy, but since it is not solving the underlying problems, efforts to tame inflation could be derailed. High public spending seems to be the “original sin” that is not addressed nor corrected.
If Macri does not accept the truth about government spending, his last two years in power could run into financing trouble in the face of persistent fiscal deficits.
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