Argentina’s Way of Putting a Cap on Inflation: High Inflation ruled–out by Definition?

The following piece appeared in RGE-Monitor (Latin-America) on Mar 7, 2008

Argentina’s authorities are working on the design of the new Consumer Price Index—as if the previous one had problems, other than its “ex-post editing”.

The (almost official) information available (clarin) suggests that some elements of the new computation of the CPI could include:

1. Seasonal products: only the cheapest will be considered
2. Not computing
1. goods that experience price increases greater than 15% (assuming people won’t buy them)
2. health insurance payment other than “co-payments” (which are relatively few)
3. travel abroad
4. Private education expenses
3. Lower number of consumption goods in the consumption basket: it will be mostly focused on the basket of goods and services of lower-middle class families which:
1. could potentially be modified at discretion
2. it will be mainly based on food prices that are in one way or another under price controls
4. The weights in the consumption basket could be modified on a monthly basis
5. Giving more importance to the goods sold by supermarkets (as opposed to small stores). The latter, in turn, could be based on price-controlled goods and could be based on the reported prices rather than the true selling prices.

If the information above is true (to be seen) not only Argentina will increase the degree of default on its debt (a huge share of the debt is indexed by CPI). Argentina, by definition, will be ruling out high inflation—not least hyperinflation. Why? See (2)(a) above!—and not taking into account that the faster prices rise, the more (instead of less) of the goods would be purchased. The more so if one takes into account that for this methodology to be viable we would need to know the price elasticities of these goods. This is an experimental methodology in the U.S. where the amount of information and consumer surveys can support it. Because of this, this price index is reported along with a regular CPI, PPI, core inflation, etc. In Argentina, on the contrary, the plan seems to be to report this new index as the only CPI…

Some long-run implication of the above: around 50% of the pension funds firms’ assets are indexed by CPI. Then, the default also affects future retired people. On the contrary, instead of letting these firms (AFJP’s) invest their funds freely to maximize the expected profits of its to-be-retired people, the government wants AFJP’s to finance investment. It is the government’s role to set up the long-run institutions and sound macroeconomic policy for investment to increase, not force it. This partly results from the decrease in FDI that Argentina is experiencing—as opposed to our neighbor countries.

Actually, the opposite is being done. Argentina’s inflation is separating more and more from international inflation. This strongly reduces the incentives for long-term investments.

So far, consumption has been growing. This is partly due to the expansionary policies of the government and the crossed subsidy system—so people are paying for the higher prices anyway. It is also resulting (more and more over time) from the acceleration of the inflation rate. Argentines are unfortunately very knowledgeable of high inflation. When it accelerates, demand for goods increase to anticipate future higher prices, reducing the demand for money.

We also have to hope that commodities markets continue as they are. However, the debate has already started: is this a long-term effect or just a bubble where the savings glut has been propelling commodities’ prices (see RGE-Monitor, March 6^th)? If the latter were the case: will that be a yellow light, or a red light altogether?

However, could stagflation be knocking Argentina’s door in 2009? This is cannot be ruled out—and it’s in part conditional on commodities markets and the global effects of the current U.S. recession/slowdown. If so, we have to start internalizing a big future problem. For 2009 is an election year. This government is extremely biased to pump up aggregate demand through fiscal policy; the more so with a faltering consumption. But with high inflation already in place…

Argentina’s authorities would claim that the recent economic growth has not been seen for 100 years. This is not false. But it is also true that the rest of the world economy has been growing at high rates for last 5 years (say the China-India effect if you want to). On the contrary, I would claim that Argentina the later has helped Argentina grow despite the highly mismanaged macroeconomy. Argentina has been in front of a once-in-every-100-years chance to make a big step to long-run growth. We could be missing the opportunity, though.