Macro policies and stability: Argentina in the trilemma (1st part)

By Hector Rubini USAL

The fluctuations of inflation, the exchange rate and interest rates have been at the core of macro instability for no less than 50 years. Stability in other countries has not followed a single path, but they have been reasonably effective. In addition, for no less than two decades there is a large literature on what is known as the "triple dilemma" or "trilemma" of macroeconomic policies: the impossibility of achieving simultaneously: a) full exchange stability (fixed exchange rate or almost), b) free capital mobility, and c) autonomous monetary policy, oriented only to internal market objectives and restrictions.

In the case of Argentina, at least, capital controls may be ineffective. Something already observed in the K years, and also in the first two weeks of the controls in force today in our country. The “counted with liquidation”, the “MEP dollar”, the footsteps to the delivery of physical dollars to the depositors and other “frictions” will charge more complexity and depth, at least until the end of the year. A reflection of official concern about the impact of exchange rate volatility on inflationary expectations.

The latter, exogenous for the monetary authority today, will continue to condition the path of "monetary control" rates. Without the help of other instruments, it is not feasible to maintain a stable path of low volatility interest rates, and market mood stabilizer.

The utility of the latter has been at the core of the debate in several developed countries on how to implement a credible and sustainable monetary and fiscal policy scheme over time. In the United Kingdom, for example, the Mais Lectures of the University of London, record outstanding discussions on this subject, such as the 1984, by Nigel Lawson, former Finance Minister, the 1984, former Prime Minister Tony Blar, and that of 2005 of the former head of the Bank of England, Mervyn King. The latter, concerned about the lack of complete information on the mechanisms of monetary transmission, presented a form of implementation of an inflation targeting regime. His "Maradona Rule" for interest rates is quite simple, assimilating a credible central bank to Diego Maradona's maneuver when he scored Argentina's second goal for England in the 1986 World Cup. With Maradona advancing at full speed, the English expected him to deviate, but he did not, and thus managed to overcome them and convert the goal. Market interest rates behave in the same way: they move greatly according to how the Central Bank is expected to act. If this is credible and sets a well-defined course, the Central Bank can influence expectations, without large movements in interest rates.

In a small and open economy, this obviously requires some preconditions. If there is free movement of capital and a fixed exchange rate, the help of a fiscal and indebtedness policy is required to reduce volatility and the level of the country risk premium to minimum levels. On the other hand, a really independent central bank is also required, with a solid reputation, not conditioned by fiscal or other policy restrictions, and also that the fluctuations in interest rates and the reading of their financial system are enough to stabilize inflation expectations in the short term.

If even with the apparent autonomy of the monetary authority, companies and families expect and observe that the behavior of the Central Bank is changing, their reaction to changes in monetary policy decisions will also change. Specifically, even within the restrictions of the trilemma, the influence of interest rates on expectations depends not only on each alteration of the monetary policy rate but on the ability of the entire Government's overall policy scheme to condition the expectations of Inflation and price adjustments.

As King well observed in his 2005 conference, just as Maradona could not convert goals in all matches just by running straight to the rival goal, a central bank cannot expect to control inflation while still keeping the monetary control interest rate still. Reaching a certain goal sometimes requires keeping the monetary control rate fixed for quite some time, sometimes not. But when the immediate objective is the stock of international reserves, or the exchange rate, inflation control by the central bank is very complicated. If this is perceived by choosing either between a set of alternative rules of doubtful compliance, on the one hand, and pure discretion, on the other, the uncertainty is likely to increase, and its announcements and operations in the exchange, bond and exchange markets interbank loans lose effect, at least until another regime is announced.

In the current Argentine case, the “rule” agreed with the IMF that the monetary base should grow 0% seasonally suggests that together with the variations in the daily rate of the LELIQ should be sufficient to stabilize prices. But this means assuming that the private sector should be “induced” to ignore other factors with a short-term impact on observed inflation, such as fuel increases, public tariffs and other regulated prices, and also on expectations and speed of money circulation, such as the exchange rate and the country risk premium. Something non-existent, as reality has shown in previous years, under the frustrated essay of inflation targeting.

From the beginning of its application, it was expected that the “rule” agreed with the IMF would induce a liquidity contraction, especially after the LELIQ rate increases before each exchange rate spike. Its fundamental effect has been to induce a marked rationing of credit, effective to induce a persistent recession, but as an anti-inflationary instrument, it has been a resounding failure. Everything would indicate that the next administration would be willing to leave from the first day of its management. But the trilemma will not avoid certain unavoidable and probably unpopular choices, which will be analyzed in the next note on this topic.