In Argentina’s delicate post-crisis economic landscape, inflation targeting isn’t the answer, central bank policy needs to reflect the transitional phase of the Argentine economy, says Martín Redrado.

It has been five years since Argentina’s unprecedented financial crisis, which caused significant structural changes after the peso’s devaluation, including the destruction of the financial system and of many economic institutions. Today, Argentina is in a transition stage, where key economic variables have not yet reached their long-term equilibrium levels, which has further implications for the conduct of monetary policy.

As our history shows, spasmodic growth cycles followed by crises are not harmless and have involved significant costs in terms of income. These fluctuations have had devastating results. Against this backdrop, the Central Bank of Argentina is building an automatic stabiliser through its policy of foreign-reserve accumulation, which provides more than $37bn of external liquidity and creates much-needed insurance to reduce external vulnerability.

Road to recovery

While the economy recovered fast and is now growing vigorously, normalisation continues. Monetary policy transmission channels are being rebuilt and the private credit market accounts only for 10% of the economy. But, the highs and lows with which monetary policy operates are unpredictable, so the effect of interest rate fluctuations on the real economy is minimal.

This model of transition after collapse is not exclusive to Argentina. Countries that suffered similar deep economic crises – such as Chile, Mexico, Russia and Brazil – also took a long time to stabilise their economies and achieve sustainable growth, though none suffered a collapse as profound as Argentina’s. Their route to recovery involved the achievement of fiscal solvency, external debt normalisation, and the restructuring of the financial system while avoiding a sequential acceleration in prices. In fact, these countries put in place gradual policies to tackle the normalisation period and faced double-digit inflation for several years after the breakdown. So, the Argentine economy is simply at a different stage compared to the current situation in those countries.

The central bank strictly controls the equilibrium between supply and demand in the monetary market, so that sustained growth in foreign reserves does not affect monetary stability. Therefore, since 2005, it has used all sterilisation instruments available. Thus, new types of securities issued by the central bank increased the average life of the portfolio. At the same time, we introduced incentives for the early repayment of rediscounts granted to financial institutions during the crisis. This reduced the number of banks indebted to only one, as compared with the initial 24. We also utilised the reserve requirement policy to prevent any potential excess money supply. A period of deep sterilisation was thus completed, absorbing about $23bn since 2005. These operations – foreign reserve build-up with sterilisation – did not affect the central bank balance sheet: the quasi-fiscal surplus exceeded $600m both in 2005 and 2006.

The effectiveness of these policies was reflected in the deceleration in growth of monetary aggregates, which are rising below the expansion of nominal gross domestic product. Since 2005, reference interest rates have been gradually hiked through operations in the repo market and the weekly placement of securities. Consequently, market interest rates more than doubled and ex-ante real interest rates started to near positive levels. The monetary targets were accomplished maintaining a strict control on the growth of means of payment without affecting the central bank’s balance sheet.

However, anchoring prices requires co-ordination between monetary, fiscal, wage and competition policies. Monetary prudence has positively contributed to reducing last year’s inflation, evident in the stabilisation of core inflation since mid-2006 and the improvements in terms of less widespread rises and less persistent price adjustments in the various time horizons. This trend was reflected in a significant drop in inflation expectations.

We consolidated a monetary policy framework based on the control of money supply, which still makes intensive use of relatively liquid means of payment and has a relatively low bank penetration. In the meantime, we continue to develop the institutional and financial infrastructure that will lead to a regime with inflation targets and a pillar based on monetary aggregates.

Martín Redrado is governor of the Central Bank of Argentina.

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