Some Reflection about the Inflation Process in Argentina

Argentina’s inflation is now approaching the 20% range, as it has recently accelerated from the mid-teens levels. There is now a heated debated about its causes, the possible paths that inflation can take in the future and the key variables that one needs to monitor in order to try to predict where it can go.

In contrast to previous episodes, this inflation process, which started towards the middle of the decade, was not driven by the needs to print money to finance the fiscal deficit. Instead it was a result of a combination of factors.  On one side, the economy started to reach full capacity in many sectors and there was starting to appear a large number of bottlenecks.

Despite the need to slowdown the growth in aggregate demand, macroeconomic policies continued to have an expansionary bias. On the fiscal side, nominal expenditures where growing at annual rates above 20%, which meant that there was a clear fiscal impulse despite the fiscal surpluses that the Government maintained during those years.

The Central Bank did not take upon itself the task of fighting inflation, as monetary growth accompanied the evolution of nominal GDP and in this sense it followed an accommodating monetary policy while providing an expansionary bias by keeping nominal interest rates well below inflation.

As a result macroeconomic policies were aiming at lower rates of inflation, but instead they maintained sustained growth in nominal aggregate demand. While there was ample excess capacity (as in the 2002 to 2004 or 2005), this increase in demand was satisfied through a rise in aggregate supply, but once this excess capacity started to disappear most of the pressures fell on inflation.

To make matters worse the Government granted large wage increases (of around 20% per annum), as the unions became stronger once the rate of unemployment fell to one digit.  Besides, it was a way to show gratitude to the union leaders that were key supporters of the Government.

Inflation receded in the second half of 2008, after reaching 25%, thanks to the international financial crisis that affected aggregate demand and caused the first recession in the Kirchner era and the fall in commodity prices that removed some of the pressure on food prices.  However, this was a short pause, as inflation started to accelerate again since the last quarter of last year and is now becoming a monster that is difficult to tame.

In summary, during these years there has not been an anti-inflation policy. Perhaps the only exception has been Secretary Moreno, who single handed tried through the use of price controls and guidelines to keep a lid on price increases.  

But the policy inconsistency of the past implied that these attempts to rely on controls and intimidation were short lived and inflation is again on the rise, and this time the risks are higher.  The main problems are now the Government needs to resort to the Central Bank to meet the financial requirements and the fiscal deficit as it has no access to the markets, unions remain strong and monetary policy still has a clear expansionary bias.

These expansionary policies are in place after four years of double digit rates of inflation and when workers and firms have already incorporated expectations that in the best case scenario inflation will remain at 20%.  Inflation inertia is dominating the process, and experience shows that once this type of process starts it is difficult to reverse it.

In the meantime the Government is making two big mistakes in its analysis of the causes of the inflation process. First, it argues that this is a realignment of relative prices (namely meat and wheat) instead of realizing that this is a generalized and persistent increase in the price level.  What they don’t see (or don’t want to admit) is that most wage and price adjustments are staggered over time and hence there is always one price that explains inflation in a given month. The fact is that all prices and wages are moving upwards, though not all simultaneously.

The second and certainly more risky mistake is that the Government has been arguing that “supply constraints” are the main reason for the recent acceleration of inflation, so-called as “relative price adjustments” by the Government. Indeed, there are some “supply constraints” in some durable and non-durable final consumption products, as some food products. Specifically, the indexes of capacity utilization in the durable and non-durable final consumption products have remained in the last two months in the maximum levels of at least the last ten years, suggesting that there is excess demand in those sectors, despite the 2009 recession, in part as a result of a relatively lower investment. This result may not be a surprise, since several of those sectors in last years have been under Government intervention and regulation, such as several food sectors (meat, milk, wheat, etc.) or public utilities (electricity, natural gas, etc.), with regulated prices and exports quotas. Due to the lack of investment incentives, output and installed capacity in those sectors remained relatively stagnant in past years, and even decreased in several cases.

While the supply constraints have been a factor affecting inflation, though it is wrong to conclude from this evidence that the Government will be able to deal with this issue through increases in supply. Here, there and everywhere when there are generalized pressures by aggregate demand excesses in the short run the only solution is to restrain demand or to increase imports.  Argentina is not likely to follow neither recipe so the effects should be very clear.

Aggregate demand is now growing at around 20/25% per year in nominal terms. The Government believes that the answer is to increase supply, and hence it is meeting with producers to diagnose where the bottlenecks are and to try to provide credit lines to get them to invest and increase production.  The argument does not take into account that investment takes time to mature and to have effects on production, nor does it calculate how much investment needs to increase to generate real growth of around 8 percent (certainly much more that the current 22% of GDP).

All the risks appear to be on the upside, as the Central Bank seems ready and able to maintain large rates of monetary and credit growth and interest rates that remain negative in real terms, while the Government plans to keep the current high rates of growth in nominal expenditures and to resort to the Central Bank to obtain the necessary financing.  This is an explosive mix. 

Despite all these concerns there is a caveat. It would be prudent for our readers to disregard the uneasiness about inflation presented in this analysis as it was done by a so called neoliberal, orthodox economist, who does not fully understand the virtues of supply side economics, nor Say’s Law in reverse (that demand creates its own supply).