Is interest always interesting, Dr Hale muses in his latest email:
“As I write, President Mauricio Macri and team are heading out for their spiritual retreat in Chapadmalal – something I feel to be my permanent condition in my remote academic ivory tower in New England. If last week I opined that Federal Reserve chairs are overrated (even Alan Greenspan, who filled that seat for almost two decades), I’ve now started thinking that monetary policy must carry even less clout in an economy like Argentina. Plenty of speculation as to which way the Central Bank would jump after the long weekend for Carnival – would Ash Wednesday or a Saint Valentine’s Day minimassacre of interest rates prove suitable metaphors (in the end nothing changed)? And all that speculation for what? In a dollarised, consumer-driven economy with one of the world’s highest inflation rates (both wage-push and cost-push), I really don’t see interest rates as having any influence on either prices or the growth cycle.
“Last week I also quoted Ronald Reagan’s: ‘I never worry about the deficit – it’s big enough to look after itself’ – something along those lines must surely be appearing in Donald Trump’s Twitter on the basis of his 2019 budget. He’s really tossed fiscal discipline right out of the window, adding not billions but trillions to the national debt over the next decade with tax cuts galore and over US$700 billion for the Pentagon (more than the entire Argentine economy). In this context I find the critiques of Macri’s gradualism by some of your orthodox economists harder to understand – why knock poor old Macri for moving slowly in the right direction when you have Trump galloping the other way?”
“In fact interest rates are never really interesting because they are always a means toward an end – for the financial sector they are the key to balance and solvency while for the policy-maker they serve to control prices or to stimulate growth (and also to encourage savings, although that seems to be an increasingly obsolete notion nowadays).
“I certainly share your scepticism as to whether these ends are served in Argentina. Always a consumer society with that identity strongly boosted by the consumer-led growth in the first decade of this millennium, it will take more than gradualism to shift that paradigm (paradoxically enough, the consumer-led growth of Kirchnerism was actually export-led via commodity prices whereas Macri’s attempts at export-led growth so far have imports growing 20 times as fast). Regardless of the interest rates, your average middle-class Argentine will be thinking of the next car or television set ahead of Lebacs etc. – that Lebacs enter the question at all is something new. This can and should change in tandem with mortgages replacing cash-down housing purchases but as things now stand, domestic credit is struggling to be 10 percent of the economy as against around double gross domestic product in the United States. So what kind of margin does that give interest rates to influence the economy?
“So if interest rates do not decide prices, what does? There are two main clusters of theory here – the monetarists pin almost all the blame on the fiscal deficit while another school of thought has it that around two-thirds of inflation reflects wage increases, while the dollar determines the remaining third almost to the exclusion of any other factor. Incomes policy and the exchange rate thus outweigh monetary policy. After three months of inflation averaging two percent, prices are now the uppermost concern for Argentines (and hence presumably for a government already preparing for next year’s presidential elections) – almost half the population, according to opinion polls, in a world where far more countries fear the threat to employment from robots.
“Of the two classic functions of interest rates, more people will thus be looking for taming prices than the stimulation of a growth now comfortably into its second year – this growth should not be underestimated as a factor in inflation, by the way, even if most analysts prefer to focus on the 20-pesoplus dollar or the drastic increases in the pricing of hitherto subsidised public services. Within that context only the spread offers any margin to cut interest rates although the competitive disadvantages of peso appreciation are also a powerful argument against tight money.
“And what about the orthodox monetarism blaming the fiscal deficit (which in turn leads us to Trump)? Merely comparing the fiscal situation here to Trump’s 2019 budget should tell us that there is no simple correlation between deficit and inflation. If Macri has already brought the deficit down below four percent of GDP and should be on course for this year’s target of 3.2 percent while Trump’s 2019 budget is looking at 4.7 percent (even allowing for the fact that the Argentine figures are primary deficit so that adding debt service would take them beyond 4.7 percent and then some), US inflation should be in the roaring 20s like here instead of struggling to reach an annual one percent.
“Nor is the difference between inflation in the two countries explained by printing money because the US has been minting greenbacks in industrial quantities in the decade of quantitative easing, more than trebling the monetary base since 2008. It has more to do with the motives for printing money than the volume. Argentina currently has two methods of deficit financing, both leading to monetary expansion – either the pesos are printed directly to plug the gap or debt is incurred, which entails not only printing the pesos to buy the dollars but also issuing Lebacs to absorb the excess liquidity. Yet to the extent that the liquidity is absorbed, the causes of inflation must be sought elsewhere.
“While in no way decisive, interest rates are not entirely neutral either. Lower interest rates will ease the exchange rate (which was much of the point behind relaxing the 2018 inflation targets at the end of last year), thus improving the trade figures both ends (and hence the balance of payments) by helping exports and making imports more expensive. Upping rates is less clearly effective in taming inflation because of Argentina’s stunted credit universe – in local experience recession is a stronger antidote to inflation but even if rising prices are now the leading public anxiety, the government hardly sees a downturn as an election-winner. An interesting question of yours, Dr Hale, and I hope the answer has been of some interest.”