Federico Sturzenegger closed the 13th International and Monetary Economics Seminar at Universidad Nacional de La Plata

The Governor of the Central Bank of Argentina, Federico Sturzenegger, closed the 13th International and Monetary Economics Seminar organized by the School of Economics at Universidad Nacional de La Plata, which took place in the main lecture hall of the aforementioned School.

The full speech follows:

Closing speech by the Governor of the Central Bank of Argentina, Federico Sturzenegger, at the 13th International and Monetary Economics Seminar organized by the School of Economics at Universidad Nacional de La Plata

It is a pleasure and an honor to come back to my home at Universidad Nacional de La Plata (UNLP). To me, speaking here is really meaningful not only because in these classrooms I did my studies in Economy with lecturers who devoted themselves to teaching and training us, but also because some years later I was honored when I was granted a lecture position on international finance. Even though my work duties led me in other directions later, I am still thankful and in debt with this institution. I only hope to be up to the commitment that lecturers demonstrated to me. That commitment motivates us every day to face the challenge of the tasks assigned with values and the utmost professionalism.

In the last weeks, there has been a discussion about the role of monetary policy in the fight against inflation. After a decade of sustained high inflation and a chronic inflation record, coupled with the international success in the fight against inflation, it is surprising that this relationship is still a discussion issue in Argentina. However surprising this may be, it does not mean debates do not take place or we should not have a position in that respect.

By way of digression, at the beginning of this month we did away with the remains of what was called exchange clamp. Particularly, we eradicated the last restrictions for the peso and foreign currency exchange transactions. This implied, among other things, replacing a strict paperwork system, which generated cumbersome bureaucracy and countless hidden costs, by a simple reporting system that adjusted to the OECD countries’ practices and to the G-20 indications. Our motto during the Board discussion was that we could venture to be a normal country. It took us a long time and nearly five years of a standstill but we have just overcome that milestone.

Why have I distracted you with that digression? Because I want to set it as an example to show it is easy for Argentina to learn about economic practices from better practices in the world. It is just a matter of making use of international experience, of learning upon the way gone by others. Thus, instead of trying to reinvent the wheel and of thinking we will do things better, we choose to work over what was learnt in other parts of the world.

First I would like to make a comment because the same takes place in the monetary policy field. Let me start by revisiting a statement quoted by Mario Draghi at a meeting of Central Bank Governors in Basel some months ago. Dragui said:

“In the last half century central banks have come a long way in how they approach their macro-stabilization functions. As recently as the late 1970s, views still diverged across advanced economy central banks as to the efficacy of monetary policy in delivering price stability. Some, such as the Bundesbank and the Swiss National Bank, were already committed to using monetary measures to control inflation. But others, such as the Federal Reserve and various European central banks, remained more pessimistic in their outlook, believing that monetary policy was an inefficient means to tame inflation and that other policies should be better employed.

Illustrating this view, Fed Chairman William Miller observed in his first FOMC meeting in March 1978 that “inflation is going to be left to the Federal Reserve and that’s going to be bad news. An effective program to reduce the rate of inflation has to extend beyond monetary policy and needs to be complemented by programs designed to enhance competition and to correct structural problems”.

In this context of timidity about the effectiveness of policy, inflation expectations were allowed to de-anchor, opening the door to bouts of double-digit price rises. The outcome was a phase of so-called “stagflation”, where both inflation and unemployment rose in tandem.

The policy lesson that emerged from this period was that sustainable growth could not be separated from price stability, and that price stability in turn depended on a credible and committed monetary policy. From late 1979 onwards – with Volcker’s assumption of the Fed chairmanship – central banks converged towards this orientation and took ownership for fulfilling their inflation mandates. As their renewed commitment to control inflation became understood, inflation rates fell steeply in a context of improved anchoring of inflation expectations. Central banks abandoned the self-absolving notion that price stability depended on other, non-monetary authorities.”(1)

It is worth thinking about the former paragraphs to understand that inflation was overcome in the world because central banks committed themselves to its reduction by resorting to tools, which proved to be enough, and produced convincing results.

We have learnt from such successful experience that the Central Bank’s autonomy is of vital importance. This autonomy is central because an important part of the agenda on low inflation rates requires that the commitment to reduce inflation will not be determined by political emergencies or short-term objectives. Even if the Central Bank’s objective is a low inflation rate or a dynamic economic growth, monetary policy should not be subject to the latter for it can produce a boomerang effect given that inflation rate will only be low should the Central Bank not surrender to short-term objectives.

This is just retrieving Barro-Gordon’s (2) intuitive model that the students here will study in the macroeconomic course. If the Central Bank surrenders to short-term objectives, then this temptation is foreseen by agents. The result will be high inflation expectations to discourage the Central Bank of any expansive attempt or, in other words, inflation with a standstill.

The Central Bank’s autonomy would then break the trick that Barro-Gordon’s model poses, allowing the monetary authority to simultaneously achieve low inflation without effects on real economy.

Within this theoretical framework, some colleagues’ comments are to be worried about. They state that monetary policy should be “complemented” with other mechanisms. I think that those who suggest these alternatives justify them within Barro-Gordon’s conceptual framework. According to them, some input policies (fixing the exchange rate or making a social agreement) would allow the reduction of inflation expectations, thus helping monetary authority. However, conditioning the expectations’ drop to policies not implemented by the Central Bank, which do not have either the timing or the long-term forecast that the monetary authority does, is basically to think that the success of the Central Bank lies on policies conditioned by short-term objectives. In this framework, it is impossible to coordinate expectations helpfully and convincingly in the long-run.

In considering this objective of being a normal country, we should not confuse the difficulties that any policy implementation involves with the wrong idea that we have a special economy. We always hear that “Argentinians think in dollars, that distributive conflicts are particularly difficult to solve, that market structures are especially prone to create inflation, or that this is an “every man for himself” economy”. In my view, any of these things are present in any economy, and people’s reactions and policy results would be identical in other parts of the world if the same incentives and policies were implemented.

My professor Rudiger Dornbusch said that in every country he visited he was told: “you have to understand this is a special country”. Then he added, in a good mood: “They were not even original at thinking they were original!”

It is important to understand that our deflation process has no distinctive feature. In fact, the strain we went through was also experienced by all the countries that deflated. So I think the main challenge for the coming months is to make price makers understand that now they face a different regime, not a different scenario.

It was common to hear entrepreneurs say “my prices were out-of-time” or “I need a currency devaluation because collective bargaining resulted in very high costs”. These are typical expressions of another regime in which prices had an inflationary dynamics that ended up being accepted by monetary authorities. Alternatively, it was a consistent process with an inflationary dynamics carried out by former monetary authorities.

At present Argentina is immersed in a different monetary regime. In this new scenario, the Central Bank fixes inflation targets and resorts to all the tools within reach to achieve them even if that implies fixing the interest rate at 38% for several months. Likewise, monetary policy does not adjust to inflation expectations. Rather it causes agents’ expectations and actions to be coherent with the Central Bank’s objectives.

That was exactly what Draghi referred to.

If this new regime is not clearly understood, i.e., expectations are detached from monetary authorities’ measures will make the following deflation process harder.

Now, let us suppose that both deflation mechanisms and inflation targets are clear enough. In other words, the monthly inflation rate is expected to turn down to 1.5% in the last quarter, to range from 12% to 17% during next year, and to plunge to 5% for 2019. Anyway, someone may wonder “why will it work?” “How could I know that inflation targets will be attained?”

At this juncture it is important to go back to Draghi’s comments and to bear in mind that inflation is defeated in the monetary market. Price level is nothing but the representation of money price. If there is more money than the amount people need, money price will fall or, in other words, the price of goods will rise (relating to money). This phenomenon is called inflation. That is, whenever there is more money than people demand (either because of an offer increase or a demand decrease), there will be inflation.

Therefore, the road towards fighting inflation is to build a schedule in which both money offer and demand could strike a balance. Upon the consistent implementation of an institutional schedule aimed at balancing the domestic monetary market, the “engines” that give rise to inflation come to a halt. Thus, a schedule with these characteristics that matches monetary offer and demand will enable inflation rate to fall dramatically in Argentina.

For instance, a way of balancing money offer and demand, as used in our country in the past, is to set a fixed exchange rate regime given that if there was more money flow than wanted, people would buy foreign currency. Argentina tried it that way during the Convertibility period, for example. Moreover, it did it with the same Argentinians, the same trade unions and the same big company owners we have today, and there was no inflation.

However, now we know from our own and other countries’ experience that having the exchange rate as mechanism to balance the monetary market is not a good idea because economies are under risk of external shocks without any tools to soften their effects. For Argentina, this has always been a kind of trap.

Thus, our monetary market balance mechanism is that of inflation targeting, which fixes an interest rate allowing money quantity to make endogenous adjustments and the exchange rate to fluctuate. Money not wanted at those rates is simply taken over by the Central Bank.

The current BCRA management has always focused on the search for monetary market balance. At the beginning of our administration, we devoted ourselves to withdrawing the monetary base excess (some estimations place it at 75 thousand million pesos) that the previous administration had left and we did away with the exchange clamp. During that half of the year, 54 thousand million pesos were added from futures contracts we also inherited. Once most of the surplus was withdrawn, we started implementing monetary policy by means of interest rate, as successful central banks do in their fight against inflation in the world, thus allowing the amount of money to adjust endogenously to the agents’ needs. Meanwhile, we confirmed the 160-thousand-million- peso limit transfers to the Treasury in 2016, assuring that monetary policy set up inflation fall and was not subjected to short-term demands.

In addition, we have explicitly stated a clear operating rule: the Central Bank will keep the positive real interest rate with a noninflationary bias until the final objective is reached. As inflation and inflationary expectations go down, nominal interest rate should also decrease.

The result has been much anchored expectations, even after months with high inflation, mainly as a consequence of the initial impact of the implemented relative price adjustments.

In July, inflation was lower than expected. According to the Market Expectation Survey (Relevamiento de Expectativas de Mercado, REM, in Spanish), a 2.2% inflation was expected in the province of Buenos Aires but it was 2% in that province, 1.7% in Córdoba and 2.3% in Mendoza. For this reason, we expect inflation to be promptly settled with our monthly inflation target below 1.5% for the last quarter.

To guarantee our anti-inflationary policy feasibility, we have also improved our balance sheet these months. With the help of the Ministry of Economy, we exchanged a set of non-transferable bills with bonds marked to market at 16,000million dollars. Moreover, we cancelled repo transactions traded shortly after the exchange clamp with international banks, updating a small part of the repo at the lowest rate in our history (2.25% + LIBOR1m). Finally, for the first time in five years, we allocated part of the returns to increase our institution’s equity and comprise a legal reserve.

In addition, we find that our economy is to be trusted again and that there has been a net capital income. In view of this, we considered it convenient to make transactions that implied a significant rise of international reserves, boosting the BCRA balance sheet assets. Since May, the monetary authority has purchased nearly 9,500 million dollars, hence highly strengthening international reserves.

Contrary to this reserve accumulation, LEBAC issues increased with respect to April. Therefore, the liabilities’ increase is balanced out with higher assets, on which the institution counts in case of money demand fluctuations, preventing them from altering our inflation targets.

Moreover, by acting to preserve an exchange rate excessive volatility, the BCRA generally operates in the opposite direction to that of the market, thus getting favorable rates in its transactions and further reinforcing its balance sheet. This is not a distinctive feature in our case. Indeed, de la Torre, Levy-Yeyati and Pienknagura (3) state the following in a paper presented in 2013:

“Evidence shows that central bankers with inflation targets (in Latin America) do not intervene to fight against basic factors but to reduce volatility excess: they purchase dollars (thus accumulating international reserves) when the exchange rate is overrated regarding its balance and they sell dollars (hence reducing international reserves) when it is underrated. Given this is so, worries about its almost fiscal costs are exaggerated. In fact, the report shows that, once the equity gains and losses are duly considered, sterilized interventions of Latin American and the Caribbean countries with inflation targets have generated very low costs in the last decade and also, in few cases, they have produced gains”.

Let us consider other fundamental tools in our regime. Anchoring inflation expectations is basic to guarantee the success of the deflation process we have started. That is why we clearly told society which our objectives are, how we want to achieve them, how we are implementing our monetary policy and how economy variables are developing in comparison to what we expect. All this has been communicated in the press conferences I took part in after the issue of the Monetary Policy Reports and in their content, in monetary policy weekly reports, and in all communication channels between the BCRA and society. We know that transparency and proper communication of objectives and perspectives play a key role in achieving a 5% inflation in 2019.

To conclude, the downward dynamics in monthly inflation rates observed in the last months is very promising. Consumer Price Index in the province of Buenos Aires went down from 4.2% in May to 3.1% in June and 2% in July. Similarly, the indexes in the City of Buenos Aires, Córdoba and Mendoza decreased from nearly 5% in May to about 2% in July. Our advance indicators show that this is also the August trend so we are very optimistic about the future.

To end with this number review, I would like to comment on the inflation accumulated between December and June. I have chosen this period because in December we removed the main twisting that affected our foreign exchange rate and goods market and in July the monthly inflation went back to the figures we had before the exchange rate consolidation; however, without placing our economy in an unstable path.

The accumulated inflation above the previous 2%monthly tendency was 20.7% in the City of Buenos Aires and 15.4% in the provinces, mainly due to the behavior of standardized prices. If we have a look at core inflation, the reports are around 12%. Considering relative price changes in that period, it is fair to say that monetary policy has been adequate to preserve its inflationary effects. Anyway, now we have an even more important challenge, which is to get our inflation target to 5% in 2019.

I said Argentina has to venture to be a normal country and it means assuming that things can happen. If most countries have a lower inflation than ours, why couldn’t we? We should simply implement the monetary policy that worked well and venture to face the challenges that imply changing our country’s history.

(1) Passage from a speech by Peter Praet, member of the Executive Board of the European Central Bank, at the LUISS School of European Political Economy, Abril 4, 2016, Rome (self-translation). Original passage: "In the last half century central banks have come a long way in how they approach their macro-stabilisation functions. As recently as the late 1970s, views still diverged across advanced economy central banks as to the efficacy of monetary policy in delivering price stability. Some, such as the Bundesbank and the Swiss National Bank, were already committed to using monetary measures to control inflation. But others, such as the Federal Reserve and various European central banks, remained more pessimistic in their outlook, believing that monetary policy was an inefficient means to tame inflation and that other policies should be better employed. Illustrating this view, Fed Chairman William Miller observed in his first FOMC meeting in March 1978 that “inflation is going to be left to the Federal Reserve and that’s going to be bad news. An effective program to reduce the rate of inflation has to extend beyond monetary policy and needs to be complemented by programs designed to enhance competition and to correct structural problems”. In this context of timidity about the effectiveness of policy, inflation expectations were allowed to de-anchor, opening the door to bouts of double-digit price rises. The outcome was a phase of so-called “stagflation”, where both inflation and unemployment rose in tandem. The policy lesson that emerged from this period was that sustainable growth could not be separated from price stability, and that price stability in turn depended on a credible and committed monetary policy. From late 1979 onwards – with Volcker’s assumption of the Fed chairmanship – central banks converged towards this orientation and took ownership for fulfilling their inflation mandates. As their renewed commitment to control inflation became understood, inflation rates fell steeply in a context of improved anchoring of inflation expectations. Central banks abandoned the self-absolving notion that price stability depended on other, non-monetary authorities."

(2) Barro, Robert and David Gordon (1983), “Rules, discretion and reputation in a model of monetary policy”, Journal of Monetary Economics, Vol. 12, Issue 1. <

(3) De la Torre, Augusto, Eduardo Levy-Yeyati and Samuel Pienknagura (2013), Deceleration in Latin America and exchange rate as shock absorber (“La desaceleración en América Latina y el tipo de cambio como amortiguador”), LAC Biannual Report (October), World Bank. Imagen del Presidente del BCRA Federico Sturzenegger en la Universidad Nacional de La Plata

The governor of the BCRA, Federico Sturzenegger, closed the 13th International and Monetary Economics Seminar at Universidad Nacional de La Plata.

August 18th, 2016