TCS Daily

Inflation Tango

By Desmond Lachman - November 29, 2005 12:00 AM

The supportive pronouncements of Argentine economic policymakers on President Kirchner's summary firing of Roberto Lavagna, Argentina's erstwhile Minister of Economy and the country's sole remaining link with economic orthodoxy, has to remind one of the story of the mother, who went to see her son in a military parade. As the soldiers marched by, the mother swelled with pride since she noticed that her son was the only one in step. For like the apocryphal mother, Argentine policymakers seem to take perverse pride in the fact that they are one of the few major Latin American economies, which hanker after the failed economic policies of the past.

Perhaps nowhere is it so evident that Argentina's macro-economic policies are out of keeping with the times as it is in Argentina's attitude towards inflation. For many of the other major countries in the region -- including Brazil, Chile and Mexico -- have all responded to their past disastrous experiences with hyperinflation by foreswearing economic policies that might risk putting them back on the road to high inflation.

Unlike in the Argentine case, the governments of those countries have drawn the correct lessons about the corrosive impact of high inflation on long-term economic performance and about the corresponding economic benefits of low and stable inflation. In order to ensure that they do not slide back onto the slippery inflationary slope, they have ceded to their central banks monetary policy independence. And they have encouraged those central banks to elevate the attainment of price stability to the primary, if not sole, goal of monetary policy.

Sadly, Argentina finds it difficult to draw the correct lessons from its repeated harrowing experiences with very high inflation. Rather than allow the central bank to target inflation at a low level, the Argentine government requires the central bank to keep the Argentine currency at the artificially cheap level it reached in early 2002 in the aftermath of the collapse of Argentina's rigidly fixed exchange rate regime. It does so in the mistaken belief that a cheap currency will promote healthy export growth, even though the transient benefits from a cheap currency are soon eroded by the higher inflation rate that they entail.

To maintain a cheap currency, the Argentine central bank keeps buying foreign exchange reserves in the market to prevent the Argentine currency from recovering the larger part of the 50 percentage points that it lost in value since 2001. The fundamental problem with printing money to keep the currency cheap is that it inevitably leads to strong money supply growth and higher domestic inflation. This process is already in full view in Argentina as reflected in money supply growth well into double digits. As a result, while the Argentine central bank ostensibly has an inflation target for 2005 of between 5 and 8 percent, domestic inflation is already in excess of 11 percent and shows every sign of picking up further in 2006.

One would have thought that this pick up in money supply-led inflation should be raising red flags in a country that has had more than its share of hyperinflation episodes. One would also have thought that Argentine policymakers, who have been to this movie many times before, would have learnt how little it takes to have the Argentine economy off to the inflation races. Instead, all it seems to elicit from Argentine policymakers is the imposition of ineffective controls on selected prices and the ranting of its president against the supposed price gouging behavior of its supermarkets.

While Argentina's cavalier attitude towards rising inflation is perhaps the most egregious example of misguided macro-economic policy making, it is far from an isolated example. For Argentina doggedly insists that public utility rates be rigidly capped at levels that make it uneconomic to invest in the energy or electricity sectors and that have already resulted in disruptive energy blackouts. Similarly, much needed reform in Argentina's tax sharing arrangements and in its creaky banking system is indefinitely postponed even though those reforms would be vital to support Argentina's quest for sustainable long-term economic growth.

Argentina's economy has been on a secular decline since its heyday in the early 20th century, when Argentine citizens ranked amongst the richest in the world. The fact that Argentine policymakers perversely do not draw the correct lessons from their many policy mistakes dooms them to repeat those mistakes, albeit in a somewhat different guise. This is a great pity. For all Argentine policymakers need do is look across the Andes at Chile to see what can be achieved through learning the right lessons from one's past policy mistakes.

The author is Research Fellow, American Enterprise Institute.


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