Reform after the Storm: Implementing Inflation Targeting in Argentina
Fernández, Martha Carro, Ibero-americana
One of the most broadly accepted explanations of the 2001 Argentine debacle points to the inconsistencies between the key economic policies implemented during the 1990's. To be sure, the monetary and exchange rate policy anchored on the Convertibility Plan was not sustainable in an environment of growing fiscal deficit and external debt. Even tough the Argentine ratio of fiscal deficit to GDP was not elevated, if we compare it that of industrial countries, its characteristics reveal that it was unsustainable for an emerging economy. As M. Mussa highlights, Argentina has structurally experienced problems in raising its tax revenue above 20% of GDP, its debt to GDP ratio increased during times of satisfactory economic performance, and the country is prone to external shocks and to changes in financial markets sentiments (Mussa 2002).
Moreover, the "sudden stop" of foreign capital introduced a hefty restriction on the ability of the Central Bank to sustain the hard peg. While the "sudden stop" could be considered as an "external shock", and therefore not created by any economic policy inconsistency, the impact that the lack of external financing had on the ensuing of the currency crisis was primarily determined by the existence of the currency board. It is worth noting that the constraint imposed on Argentina's external borrowing practices by what Eichengreen, Hausmann and Panizza define as "original sin" - the inability of many countries to borrow in their own currency - is not only related to the macroeconomic policy inconsistencies of the 1990s, but also to structural economic and institutional characteristics of the Argentine economy that are not the object of this article.1
The purpose of this article is to analyze whether the new monetary policy path that Argentina has considered adopting - i.e., the introduction of an inflation target mechanism (IT) - is sustainable in the long-term. Our study will begin by reviewing the rationale and the design mechanisms of IT. Then we will explore the characteristics pointed by the literature as the principal requirements for a successful implementation of the IT mechanism. Thirdly, these requirements will be applied to the current Argentine economic and institutional framework in order to determine whether the system could be maintained in the long-term. We will draw conclusions in the final section with references to MERCOSUR.
II. INFLATION TARGET: AN EXPLANATORY VIEW
"Contagion" does not exclusively apply to currency crisis in emerging markets. It also seems to pertain to the macroeconomic policies established. In this sense, it looks as if IT is in fashion in emerging economies, especially in those that experienced a dramatic devaluation after abandoning a peg or a hard peg. In the specific Latin American context, Brazil, Chile, Colombia Mexico and Peru have selected IT as their stabilization tool with relative success.2
This time, Argentina is no exception to the trend. After a period of relative uncertainty in the monetary and exchange rate strategy fronts,3 in 2003 the former governor of the Central Bank, Alfonso Prat-Gay, announced that the country would adopt an IT strategy in late 2004.
IT is generally defined as an institutional pledge by a Central Bank to accomplish price stability as the primary goal of monetary policy. The direct control of inflation by the Central Bank is executed by it's fully and explicit commitment to an inflation target that is precisely quantified. To attain the target, the monetary authority steers the instrument selected. Changes in such instrument would affect future inflation through the effect on inflation expectations. While the Central Bank has room to maneuver in selecting the monetary tools, the institution should be accountable for achieving the inflation goal.
The correct implementation of this strategy requires that the monetary authority enjoy a high degree of isolation from the executive and legislative powers. …