An analysis of inflation determinants in Argentina

Inflation in Argentina has consistently been on the rise over the last twenty years, with levels above 90% per year. Most other countries in the world, conversely, have managed to maintain relatively low and stable inflation rates. Thus, Argentina has been among the ten economies with the highest inflation for 14 out of the last 16 years and is about to join the small club with rates in excess of 100% at least one year in the last decade (Burkina Faso, Lebanon, South Sudan, North Sudan, Venezuela, and Zimbabwe).

These inflationary levels are incompatible with any process of sustained growth, improved income distribution and poverty mitigation. In fact, between 2011 and 2021 Argentina’s per capita income fell by 13%, a discouraging performance far below that of other countries in the region such as Bolivia, Paraguay, Peru, and Colombia. Resuming the path to growth by curbing inflation is a necessary condition and the top macroeconomic priority.

However, there is currently no consensus on the causes of the inflationary process in our country. An accurate diagnosis is essential to tackle the problem. Fundar seeks to contribute to building such consensus by studying the determinants of inflation in Argentina, as a preliminary step in determining the objectives to be pursued by an anti-inflationary policy.

Our study is based on a theoretical framework that determines what variables to include in the quantitative exercise, to reduce the risk of omitting relevant factors. In particular, the general price level is broken down into three large price sets, each with its proximate determinants: tradable, non-tradable, and regulated. Tradable prices are influenced by the fluctuation in the exchange rate and international prices. As for non-tradable prices, two possibilities were considered: i) they were considered to be a function of money supply and demand; and/or ii) they are determined by a cost function factoring in wages, domestic and imported inputs and a profit margin. Finally, regulated prices are strongly determined by the public sector.

The method allows a distinction between short-and long-term effects. Results indicate that any increase in the interest rate or in regulated prices tends to reduce inflation in the long term, while the depreciation of the peso increases inflation. In the short term, any past inflation increases, currency depreciation and increase in the money supply tend to raise inflation with a lasting effect, unlike the temporary inflation hikes caused by an increase in the price of regulated goods or interest rates. Finally, increases in activity levels and international commodities prices do not have a relevant impact.

Argentine inflation is a multi-causal phenomenon, so any partial approach is bound to fail. Neither an income policy lacking macroeconomic consistency nor a solely and exclusively monetary approach will be effective. Instead, it needs to be approached from every angle at once.

Based on these findings, an anti-inflationary plan for Argentina should consider the following:

  1. Fiscal balance. Fiscal deficits cannot continue to be financed by printing money blindly to the impact on prices, especially in a bilateral economy such as Argentina’s. Fiscal balance is critical to allow for a more efficient fiscal policy. It is also imperative to allow the Central Bank to implement a consistent monetary policy. Furthermore, in light of the country’s social context, it is essential that consolidation be progressive, which is not an easy task given the resistance to cut down spending and the high tax burden (particularly on the formal segments of the economy). In this regard, it seems key to implement a tax reform to correct tax system inequities and overlaps. As for spending, there may be some room to reduce spending by further haircuts on tariff subsidies.
  2. Improving liquidity and financial intermediation. The Argentine economy has the paradoxical situation of having, at the same time, excessive liquidity (partially caused by financing the fiscal deficit through monetary expansion) and financing constraints in the public sector and important segments of the private sector. This may be partly explained by the fact that a significant portion of the savings of the private sector and of surplus entities of the public sector is channeled to interest-bearing securities of the Central Bank (Leliqs and Pases), which further expand the monetary base. Thus, it is necessary to improve the intermediation of the financial system in order to encourage savings in local currency and to improve the financing channels for both the public and private sectors.
  3. Reducing bimonetarism. Argentina’s dual currency economy results to a large extent from the fact that the local currency fails to function as a store of value and, in certain markets, even as a unit of account or means of payment. This impairs the overall functioning of the economic system and the effectiveness of the economic policy, in particular. Encouraging savings in the local currency requires implementing a positive actual interest rate and reducing expectations of devaluation.
  4. Aligning relative prices. Exchange rate restrictions (cepo) generate an exchange rate gap that discourages exports and encourages imports, affecting the external sustainability of the economy. The ultimate goal is undoubtedly to bridge that exchange gap. Moreover, almost all stabilization processes start with a high exchange rate to allow real appreciation as inflation subsides. The problem then lies in how to avoid the costs of devaluation, namely, the acceleration of prices, the fall in the purchasing power of income, economic recession, and the increase in poverty.
  5. Income policy. In this regard, coordination mechanisms are required to address two objectives: i) to prevent shocks, such as a devaluation, from being passed on to prices in their full magnitude; and ii) to curb inflation inertia. In a previous Fundar paper (Etchemendy and Pastrana, 2021), the authors propose a temporary social pact to collaborate in stabilizing the economy.
  6. Encouraging exports to accumulate international reserves. Stabilization requires the Central Bank to accumulate international reserves, for which an increase in exports of our economy is necessary. Fundar has presented a regulatory framework for the development of Argentina’s liquefied natural gas (LNG) sector. Argentina not only imports LNG, but also has reserves in Vaca Muerta to supply 200 years of domestic demand and with an export potential of about 27 billion dollars per year for 30 years (Arceo et al., 2022).

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