Inflation in Argentina: a monetary explanation


The crisis caused by COVID-19 seems to be seriously exacerbating the inflation problem in Argentina, where prices are experiencing a worrying escalation. In this article we will analyze its causes and consequences from a monetary point of view.

Without a doubt, inflation seems to have been the great economic concern of Argentines in recent years. All the problems that have afflicted the country lately are linked to it more or less directly. From the deterioration of the quality of life and the increase in poverty to the devaluation of the currency, through labor negotiations, taxes and public service fees.

Although there are widely varying opinions regarding its causes and consequences, what seems to be generally agreed is on the magnitude of the problem. Thus, according to official data (CIA Factbook), in the period 2002-2019 accumulated inflation was 1,169.5%, which represents an annual average of 20.43% (remember that the world average is around 3% per year).

As if this were not enough, it is evident that such a strong acceleration in prices represents an enormous opportunity cost for the country in terms of growth in gross domestic product (GDP), which partly explains why Argentina's per capita income leads 10 years practically stagnant.

Causes of inflation

One problem, multiple explanations

Anyone who has lived in the country can easily verify that there are different explanations for the origin of the problem.

One of the most popular is that entrepreneurs sell more and more expensive because they enjoy a position of preponderance in certain markets, which allows them to obtain increasing margins without reducing the demand for their products. The opposite would occur in international markets, where Argentine exporters would be forced to have more competitive prices, as can be seen by observing that many Argentine products are more expensive within the country than outside it. From this point of view, the main cause of inflation would be that companies take advantage of their excessive power in the local market to compensate for the benefits that they must give up abroad.

The problem with this explanation is that it does not take into account the dynamic effects of a differential assumption in profit rates on competition and production: if it were true that it is much more profitable to sell within the country than outside it, it is evident that There would be strong incentives for both existing companies and new business investment projects to target the domestic market, which would end up stimulating production and pushing prices down. But the reality is the opposite: consumption has been in contraction for years not because of an abrupt change in consumer preferences but because of a continuous reduction in aggregate supply.

Some analysts even argue that although the contraction of production is a reality, this is due to unfair competition practices such as the manipulation of stocksIn other words, entrepreneurs do not put all their production up for sale in order to maintain artificially high prices. Again, the problem with this argument is that it is unable to go to the after effects.

If they accumulate stocks without selling indefinitely it is clear that the costs of production of the companies would grow more than their income (which contradicts the previous hypothesis of an increasing rate of profit). Furthermore, if they tried to place them in other markets, exports would necessarily have an important and growing weight in GDP, when in reality they do not reach 15% (this ratio being relatively low compared to the rest of the world). Having dismantled this reasoning, it is not difficult to understand why the increase in exporter retentions (which in theory should redirect sales to the domestic market) has been an absolute failure to contain inflation.

Prices and costs

Another explanation is the supposed formation of prices as simple transmitters of production costs. In some way it can be said that this point of view has a somewhat more solid theoretical basis, since economists such as Adam Smith or John Maynard Keynes argued that the most determining factor in price is cost.

In the case of Argentina, the hypothesis is that there is an exogenous rise in certain production factors (imported inputs, electricity, labor, etc.) that is transferred to final prices and causes inflation. Under this approach, the origin of the problem would be in issues outside the production process such as the devaluation of the Argentine peso against the dollar, subsidy policies or wage negotiations. At times, foreign investment funds have also been blamed, whose speculation with the currency would be one of the causes of the tensions in the exchange market that later have repercussions in the oscillation of the general level of prices.

In this case, the difficulty is that the reasoning is based on the premise that costs determine prices, which has been questioned by many economists such as those belonging to the Austrian School. According to the detractors, the process would be inverse. In other words, entrepreneurs demand factors of production according to the amount of goods and services that they manage to sell (or that they estimate that they will be able to place on the market), and it is that demand that determines the prices of these factors. In other words, it would be the prices that would determine the costs and not the other way around. In the case of Argentina, this explanation is not without foundation: the destruction of employment seems to indicate that in a contracting market, companies demand less work, which translates into a reduction in real wages in the less unionized sectors of the economy. In this way, a fall in sales ends up causing a fall in the price of the labor factor.

The seriousness of the problem and the multitude of opinions on the matter have given rise to a wide variety of measures that Argentine governments have used over the years. Price controls, export withholdings, restrictions on the sale of foreign currency and even forcing companies to sell at cost are the main tools through which an attempt has been made to contain inflation. All of them have failed, despite the fact that some have been applied insistently in recent decades.

From Buenos Aires to Salamanca

What, then, is the origin of inflation? To find the root of the problem, it would be necessary for the Argentine authorities to stop looking for solutions in the failed second half of the 20th century and dare to make a trip to a somewhat more distant past, just a few years after the first Spaniards landed in the Silver river. Its about Resolutory comment on changes by Martín de Azpilcueta, author belonging to the School of Salamanca who laid the foundations for the quantitative theory of money. Azpilcueta's contribution would later be developed by economists like Fisher, giving it a mathematical form through the well-known equation M * V = P * Y

Under this model it is easy to understand that inflation is an essentially monetary phenomenon, since it depends directly on two other factors (money supply and speed of circulation), which are also. This implies that any increase in the monetary base (M) above income growth (Y) will translate into inflation (P), assuming that the speed of money circulation remains constant (V). In this way, the uncontrolled rise in prices would essentially be an indicator of the errors of the Central Bank's policy, and not of alleged market inefficiencies.

The upper graph can help us to visualize the magnitude of this error on the part of the Argentine monetary authorities, with an exponential growth of the M1 aggregate. Although we can say that the rate of issuance since 2002 was higher than the average for developed economies, the truth is that as of 2010 the trend is that each year the money supply grows faster than the previous one. In a country with such a small banking sector as Argentina this is especially problematic, since it is not even possible to blame private banks for creating too much money by expanding credit: the sole responsibility lies with the Central Bank and the continued monetization of the deficit. . The future prospects are even worse, since the coronavirus pandemic has exacerbated the crisis that was already dragging the country and everything seems to indicate that it will once again resort to printing money to finance public spending.

The situation would be serious in itself if only excess issuance could explain inflation, but at least it could be resolved with relative ease, since in that case it would be enough for the Central Bank to return to monetary orthodoxy. The problem is that there is a second factor at play: the speed of money circulation has not remained constant as most models assume, but in the Argentine case it has increased due to the generalized rejection of the currency by citizens. national.

In other words, market agents understand that a currency in constant devaluation deserves less and less confidence, and therefore they get rid of it as soon as they can (instead those who have the possibility try to save in other currencies, something that the government tries to avoid through multiple restrictions). This is not an irrational question. As we all know, one of the three basic functions of a currency is to be a store of value, and that requires a stability that the Argentine peso does not currently have. In this case, the country's own currency is rejected, but simply because its citizens are no longer perceiving it as a currency itself.

The explanation for the Argentine inflationary phenomenon, according to the aforementioned theory, is therefore found in the combined action between an uncontrolled money supply and an increase in the speed of circulation, all of which contributes to accelerating the increase in prices. This means that the causes are more related to wrong monetary policies and a generalized loss of prestige of the currency than to speculative businessmen and investment funds willing to enrich themselves at the cost of impoverishing the country.

History, like so many other times, teaches us a valuable lesson in this regard. In general, the Spanish kings ignored the work of Martín de Azpilcueta and the School of Salamanca to continue with their policy of regulations, accumulation of precious metals, expropriations of deposits and tax increases, and the result was that they converted the empire where they were not the sun was setting in a backward and miserable country. Argentina, the thriving country that just 100 years ago was called "the breadbasket of the world," seems to have taken the same path decades ago, with similar results. Hopefully it is not too late to rectify.

Still, it is worth mentioning that this is an explanation from the point of view of one of the schools of economic thought. Of course, not the only one and not necessarily the majority. And that is why we invite the reader to comment, debate and express their opinion.

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