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Federico Sturzenegger at the closing of the XX Workshop in International Economics and Finance

The XX Workshop in International Economics and Finance was held last Monday 20 and Tuesday 21 March at the Dr. Ernesto Bosch room in the Central Bank of Argentina.

It was jointly organized by the Latin American and Caribbean Economic Association, the Central Bank of Argentina, the Inter-American Development Bank, the World Bank and Universidad Torcuato Di Tella.

Federico Sturzenegger, Governor of the BCRA, closed the workshop:

First of all, I would like to thank the organizers of this conference for giving me the honor of closing the event. It has been a real pleasure to welcome you, especially with so many friends here today. We have learnt a lot in these two days.

Like in previous events held at the BCRA, these conferences have been recorded and uploaded to the web site. I am sure that they are a valuable material for our colleagues and students.

Today, I would like to talk about two fundamental objectives of economic policy, equality of opportunities, on one hand, and economic growth, on the other. I believe I am right in saying that everyone would agree that these two objectives are first priority. The Central Bank's policies play a key role in the compliance of these objectives and, in a special way, aim at both of them simultaneously. The famous dilemma between equity and growth does not come up when referring to Central Bank missions.

Therefore, today I would like to speak to the academic community. From this perspective, I would like to go over those objectives so as to gain an insight into the way they work and their implications. I hope you become enthusiastic about this subject, thus contributing to enhance the value of the agenda drawn up by the BCRA.

Although both objectives are backed by the vast majority of the population, there are forces that permanently bring policies off the road. For instance: Let's take one of the BCRA's goals that is concerned with the development of the financial system. As we will explain in more detail later, it contributes to equity and growth. Bearing this in mind, I am sure we will face the opposition of those groups that have derived benefit from a financial system characterized by an implicit subsidy transferred from depositors to borrowers at a negative real interest rate. A great part of the work of my favorite economist, Mancur Olson[1], and the latest book by Acemoglu and Robinson [2] focus on these problems (the logic of collective action and the construction of democratic economic institutions, respectively), and argue that the implementation of policies aimed at promoting the common good is an everyday task. Here academic economists play an important role, and so do independent, pluralistic universities, where students and professors as well are not conditioned by particular interests of any sector. Therefore, I think it is important to get involved and present an objective perspective on the policy topics discussed in Argentina.

Let´s get down to business. As Central Bank we have two fundamental tasks connected with ensuring equality of opportunities and promoting economic growth in Argentina.

In the first place, we should ensure capital access. This entails creating favorable conditions for saving, and for this saving to be professionally intermediated, thus bridging investment and financing.

In addition, we are to reduce inflation levels in Argentina, as it is one of the most regressive and distortive taxes.

If we neither ensure intermediated saving nor fight inflation, we will hardly reach equality of opportunities and economic growth.

From a historical perspective, we cannot but admit that our institution failed in achieving these two objectives in the past. Sadly, we must acknowledge that the Central Bank has failed dramatically. Argentina has not only one of the smallest financial systems in the region but also a faltering domestic currency. It has one of the highest levels of inflation in history.

But the most important thing is to understand our own failures. Only by acknowledging such failures and making a correct diagnosis we will be able to remedy this situation.

a. The Role of the Financial System

Let´s deal with the first concern regarding equal access to credit. I am sure you are aware that the size of our financial sector is far from the average size in other countries of the region. To put it into figures, total credit does not exceed 12% of the GDP in Argentina, whilst it represents 90% in Chile, nearly 60% in Brazil, and 50% in Bolivia. If there is no deep financial system that ensures a wide access to credit, only those that already have capital shall be able to put into practice their ideas and projects. Argentina's financial system is shallower than other countries'. So it should be easy for scholars to discover what has happened (in a minute I will give you my opinion).

Now, this unusual situation in comparison to the region has been going on for several decades. In the last Monetary Policy Report[3], we published an exercise in growth accounting, which showed a continuously negative contribution of the capital factor to economic growth in Argentina from 1980 to 2016. This means that Argentina was not able along these years to accumulate the necessary capital to boost economic growth. To be more accurate, the only thing that emerges from this picture is the desaccumulation of capital in terms of product. Of course I invite all of you to review, expand and discuss this paper.

Evidently, our diagnosis is clear. During all those years, negative real interest rates prevailed in Argentina, scaring savers away from our currency. In this context, the financial system failed to provide a link between savings and investment. Negative real interest rates ended up being a punishment to depositors, triggering a continuous flight from our local currency and, therefore, from our financial system. Then, we realize that our country has no locally intermediated saving and, therefore, no credit, which exerts a severe impact both on equality of opportunities and long-term economic growth.

The development of the financial sector entails creating a vehicle so that a greater number of persons may obtain the necessary capital to finance their productive undertakings. There are few ways of ensuring greater equality of opportunities that prove to be more effective than working for the financial deepening of our market. A country with a small system is comparable to a country where only rich people can invest. In such a shallow system we notice the proliferation of business family dynasties rather than a geographical and social kaleidoscope in the processes of capital accumulation. This is a direct relation, and does not warrant much discussion. Scholars could provide statistics on social mobility or on the concentration in processes of capital accumulation in Argentina. If we became aware of how much we have lost in terms of social mobility, we will also support such policies seeking its recovery. I wish someone here will become enthusiastic about addressing these topics.

Of course, we must also deal with the existing relationship between financial sector development and growth. There is a direct relation between capital and growth (whether you believe in endogenous growth models or not). However, today I would like to focus on two aspects that connect growth with the financial sector, which I consider fertile ground for you to analyze in depth: 1) the relation between capital access and productivity; 2) the relation between a repressed financial sector, subsidized credit and immiserizing growth.

a.1. Equality of Opportunities and Productivity

In a world with limited access to credit, people with higher initial resources have more opportunities to develop their projects than those who lack them. People with great ideas cannot accomplish their undertakings with no capital or at best they can do it in a smaller scale, probably below expectations.

Francisco Buera, in a paper published in American Economic Review[4](2011), goes even further. He argues that, within a context of general equilibrium, a world with no sufficient access to credit brings about a slowdown in the growth of companies, a delayed implementation of valuable ideas, and a trend towards smaller-scale projects with shorter-term horizons. All these consequences entail a long-term equilibrium where both the productivity of the economy and wages are lower and the access to opportunities is unequal.

Interestingly, the software industry is one of the few sectors where we have witnessed the emergence of big new companies and new entrepreneurs (such as Globant, Mecardo Libre, and OLX) that curiously exhibit low demand for capital. Janice Eberly[5] (2016) shows that these activities are not capital intensive. However, this is a palliative we cannot resort to.

a.2. Immiserizing Growth

In a country that has no intermediated saving, credit is naturally scarce. Of course, "raw material" is missing. Then, most people complain of “lack of credit”. As a consequence, they try to persuade authorities to take measures for extending credit. However, those that claim for credit are not willing to pay their real value of such credit—i.e., paying for deposits to be intermediated in the financial sector—so financial institutions are forced to lend at subsidized rates.

As a result of this type of dynamic, projects financed at a real negative interest rate are likely to entail a real negative rate of return. This has a dramatic effect because it implies that capital allocation, far from generating economic growth, creates immiseration. This may lead to unprofitable activities, preventing these resources to be channeled to more profitable activities and with greater social benefit.

Capital allocation to projects with a negative internal rate of return certainly destroys capital, instead of causing it to be multiplied. There is extensive literature in international economics on the concept of “immiserizing growth”[6], Jagdish Bhagwati being one of the main exponents. This literature discusses how economies with relative and severely distorted prices created investment patterns that, at international prices, reduced the GDP. I believe we have to reflect critically on this topic which, in my opinion, is rooted in the low yields of our investments and low growth in the last 5 years (among other reasons, of course). Once more, I invite academic economists to explore and develop these concepts.

a.3. Where are We? Where are We Heading?

It is time to leave behind such shortcuts that take us nowhere. Today moving in other direction is imperative. For many decades banks have developed a strategy retracting their business and only acting as players on the transactional side of the economy. This means—and I say it emphatically—resigning their role as links between savings and investment. This is evidenced by the fact that 49% of private sector deposits in pesos are on sight and 89% of term deposits do not exceed 90 days.

Therefore, during the last decades, the financial system's strategy consisted in taking advantage of part of the inflationary tax. This allowed banks to take deposits at almost zero cost and then reinvest them in loans or financial instruments that gave back positive return. The higher the inflation in the country, the higher the difference between deposit and lending rates and, therefore, higher profitability is obtained.

However, low inflation prevents the continuous implementation of this strategy. Against a backdrop of disinflation, financial institutions shall have to redesign their business plans with the aim of increasing the scale of intermediation, and reducing their operating costs. The implicit subsidy transferred to financial institutions in a context of inflation caused operating costs to remain higher than current costs in other countries of the region[7]. Therefore, as the disinflation process continues, our banks must rearrange their activities and objectives in line with these horizons.

This is one of the issues that are at the core of the BCRA agenda, and therefore we have already implemented many initiatives to reduce operating costs within the financial system and stimulate their scale (de-bureaucratization as to the opening of branches, electronic deposit of checks and encouragement of competition among cash-in-transit companies, just to name a few measures[8]).

We have already started to witness this process at an early stage. As a consequence of a low inflation rate during the second half of last year, banks achieved low profitability. Their profits increased by 24.4% in 2016. This is the lowest annual growth of the last 8 years, during which the average increase was almost 42%. Profitability gradually fell quarter after quarter as disinflation consolidated along the year. This clearly shows the challenge that lowering inflation would pose, a scenario towards which we are heading.

Now, let's analyze the paradox of the former government. According to their political discourse they claimed to be bitterly critical of the financial system; however, at the same time, they boosted inflation to finance themselves, which ended up triggering high levels of profitability from a historical perspective. In fact, over the last eight years the annual growth of financial institutions' profits peaked at 66%, 58% and 50% in 2009, 2014 and 2013, respectively.

In order to stimulate the development of the financial system, this administration has introduced, among other measures, the so-called Units of Purchasing Power (known in Spanish as UVAs), account units tied to inflation which are aimed at safeguarding savings in domestic currency and fostering long-term credit. In my opinion, such a tool will allow us to address one of the worst deficits of our financial system: extremely short-term investment horizons both for deposits and for credits. The inclusion of UVAs both ensures positive real interest rates in the system and reduces uncertainty regarding the real value of intermediated funds.

Mortgage-backed loans are par excellence the type of credit that should be viewed in a long term perspective. UVAs safeguard the real value of the capital granted, so the initial installments of a loan are no longer expected to compensate the whole real loss of the future value of such loan. Clearly, the public's increasing request for mortgage-backed loans in UVAs has considerably grown as installments plunge as low as rental payments. Loans in UVAs have been rising by $1 billion on a monthly basis, accumulating more than $5.1 billion since April, when they have been launched. These figures are expected to increase in the following months.

A few days ago, PRO.CRE.AR loans were launched under this method, with monthly installments of AR$2,500 for every AR$1,000,000 lent. In the face of a shortage of mortgage loans in Argentina (90% of the population having no access to finance), PRO.CRE.AR loans make mortgage-backed loans significantly more affordable for more than 50% of households. So, if a loan was granted for AR$500,000, the installment would be AR$1,250. Thus, more than 80% of wage earners would have the chance to access loans for housing. We have then jumped from a context of lack of mortgage-backed loans to one where “any wage earner can buy their own house.” This is a revolutionary change for Argentina.

In my inaugural speech at the BCRA[9], I raised the possibility that a AR$750,000 loan would be granted with an installment of AR$2,211. Today this possibility has become a reality and as the word of a central banker is its most important asset it is worth recalling such proposition. Obviously, this implies redesigning the construction industry. Within a context of unequal opportunities to access finance as it has happened in Argentina for so long, the construction industry has chiefly aimed at the high income segments. With a more widespread access to credit, real estate developers shall have to aim at households with lower incomes. At this juncture, we are enthusiastic about the chance to radically change the housing condition in Argentina in a matter of few years.

Hence, the increased access to credit also requires that loans be granted at longer terms compared to the ones offered nowadays in the financial system, so as to avoid mismatches in the institutions´ balance sheets. In symphony with this conception, Decree 146/2017 entitles banks to issue marketable securities and/or UVA-adjusted trusts for no less than two years with a view to performing activities related to construction or real estate. In this context, banks may trade their mortgage-backed loans in UVAs, which increases the amount of available funding for these credits in the same denomination and with longer terms.

It should be noted that time deposits in UVAs are meant to be a sound investment for depositors since their savings are protected from the eroding effects of inflation. Let´s analyze a specific example that I have already mentioned several times. If a person invested AR$100 in time deposits since the beginning of the 80s, today that person would have AR$1.5 in real terms. In other words, the savings of this person would have been wiped out. In turn, if that person had had the possibility of making a deposit in UVAs, let´s say at a rate of 4%, today the amount deposited would have increased to AR$410 at constant prices. So, the real value of the initial capital would have increased fourfold. Let´s consider another case, which may probably be a surprise for many. If that person had instead bought dollars, this would not have been a better investment either. The truth is that keeping that sum in dollars until today would mean a real value of as low as AR$68.

Indeed this new tool has great potential for saving and credit. This is a key instrument for the development of the domestic financial sector, mainly in connection with mortgage-backed loans and as a way of regaining long-term confidence in the Argentine currency.

I think you play an important role in making these instruments known. This mechanism has worked in other countries many years ago (specially in Chile). However, we should make people learn in advance about the benefits of these facilities in UVAs. Thus, we should be ready to explain that the interest rate charged on a principal in UVAs is lower, that installments are similar to rental payments, and that the interest rate does not involve a payment equal to “inflation plus interest”. These facilities should further be analyzed and made known in the interest of society. I hope to awaken your curiosity so that you may shed more light on these issues and their potential long-term consequences.

b. Why Do We Pursue Low Inflation?

Let´s move on to the issue of reducing inflation, the second impact of our work as a central bank. I would like to underscore that low inflation contributes towards both equal opportunities and economic growth.

b.1. Inflation and Equity

High inflation punishes the most vulnerable sectors in excess, depriving them from equal opportunities and adversely affecting income distribution in our society. We should never forget this. Inflation is not an instrument of macroeconomic management, but one of the most regressive taxes.

In several opportunities I have showed this chart which speaks for itself:

In this scenario I find it surprising to see that many colleagues doubt about the benefits of the disinflation process promoted by the BCRA. As if Argentina's history was not clear enough, some of the professionals who discuss the BCRA´s inflation targets—which as you well know range between 12% and 17% this year and are still high at an international level—focus on the costs of achieving such inflation rate. This is genuinely surprising.

Even if one believed in the Phillips curve—which has been denied once and again along the history of our country—the decision to refuse lowering inflation as fast as possible would only become reasonable in a scenario of an extremely high discount rate. If we proposed to society the need of increasing the real income of the lowest decile by virtually 20% and the second lowest decile by 10%, I assume there would not be much strong criticism. This is at best surprising. In fact, I think people will agree on that increase and on the fact that such measure cannot wait any longer. However, if someone says, “Well, that does mean lowering inflation”, people start raising a series of doubts and making a great deal of questions. Great paradox! A paradox which is worth exploring even within the area of behavioral economics.

The failure to support the fight against inflation, and this is specifically addressed to my colleagues, implies defending income regressiveness and upholding a policy that hinders economic growth in the short and long term.

b.2. Inflation and Growth

The relationship between inflation and growth can be addressed from a short-term or a long-term perspective.

We have always held that in the short-term horizon there is nothing more reinvigorating in Argentina than reducing inflation. If we said that “to lower taxes on the low-income population is mostly reinvigorating in Argentina”, I think there would not be major objections. As I have already mentioned, this means reducing inflation.

As if the Argentine history was not clear enough (Robert Lucas [10], in his famous paper published in American Economic Review, showed Argentina with a negative relationship between inflation and growth), we can add last year's data. In the second half of 2016, inflation dropped to a monthly average of 1.4% (18.5% annualized) and the economic activity emerged from the recession it had been immersed in since the third quarter of 2015, thus posting a 0.9% growth during the last quarter according to the monthly indicator of economic activity (EMAE in Spanish). Such expansion continued during the first months of 2017.

This year does not pose a dilemma between disinflation and growth either. In fact, given the level of wage agreements, a drop in inflation redistributes companies´ income among wage earners, increasing the real salary. Those that criticize our target are indeed requesting that income be redistributed in the opposite direction, that is, from workers to businessmen. It is hard for us to follow this reasoning.

From a long-term perspective, it is worth remembering that those countries that managed to reduce their inflation rate below the 20% threshold on a sustained basis doubled their average economic growth rate over the following years[11].

Inflation harms growth on several grounds: the shortening of investment horizons and planning, the fall in the level of savings, and two other reasons I would like to highlight because they are also closely related to the redistributive impact.

One of the most harmful effects of inflation is that scant information is conveyed by prices in the economy. No one knows how much they have to pay for things and the current prices of different products cannot be reasonably used as a benchmark for calculating their price in the future. As people do not know how much things are worth, they no longer search for “the lowest price”, thus fueling a vicious cycle that develops a sort of “market power” in the distribution chain, reducing consumers' purchasing power.

Then, inflation through relative-price variability and the destruction of information conveyed by prices shifts the market balance in favor of price makers. As consumers do not know how much things are worth, and prices may change while they search for the best price, there is more room for paying higher prices than those that will prevail in the absence of inflation. This idea is a summa onery of of the most outstanding papers, in my opinion, on the consequences of inflation, published by Mariano Tommasi in American Economic Review[12]. I would like to share the following extract with you:

“Contrary to the ´administered inflation´ hypothesis that establishes causality from markups to higher inflation,(...) the causal relationship [...] run[s] from inflation to market structure and performance. Price instability moves the economy away from perfect competition....”

Tommasi proves that price instability is detrimental to market competition and, in turn, adversely affects society's welfare and markets' capacity to allocate resources. The recovery of the price system is one of the main advantages of reducing inflation.

The second effect of inflation has to do with the impact it exerts on the financial sector's capacity to grant credits in an efficient manner. In a paper I published in the Journal of Development Economics together with my colleague José de Gregorio[13] (1997) we held that: “(...) the ability of financial intermediaries to distinguish among heterogeneous firms is reduced as inflation rises, (...) productivity differentials among firms narrow as inflation increases. This effect creates incentives for risky and less productive firms to behave as high productivity firms and this may result in financial intermediaries being unable to differentiate among customers”, entailing a less efficient allocation of lending resources. This is also an example of how inflation corrupts the smooth functioning of the economy.

c. Conclusion

In sum, high inflation brings about extremely high costs, both as regards equal opportunities and economic growth. The task of shrinking the annual inflation to 5% for 2019, as intended by the BCRA and the National Government, shall be one of the most powerful engines that will make Argentina's productivity and income distribution take off.

For this reason the BCRA has maintained a contractionary bias to its monetary policy. In practice, the BCRA has kept its benchmark unchanged—24.75%—since last November, despite the dramatic inflation decline recorded between December 2016 and January 2017. As we have recently stated, with focus on the achievement of the targets, we have no room for thinking about loosening the monetary policy. In fact, we have observed that, during the last few weeks, short-term interest rates stood close to the floor of the repo corridor, so the BCRA started to sterilize the surplus liquidity in order to shift it back within the limits of the corridor.

Through such decision the BCRA aims at defending the most vulnerable sector of our economy, in particular.

Now, bringing my presentation to a close, I would like to raise an excellent topic of economic concern at the local level. As a matter of fact, I cannot resist the temptation of bringing up the idea that economists do not appear to be sufficiently concerned about the relationship between monetary policy and inflation. For most local economists, and I think I am not exaggerating, the strong monetary contraction of the first half of 2016 had nothing to do with the sharp slowdown of inflation that occurred during the second half. We should remember that inflation in the second half of 2016 was only a third of the inflation rate in the first half.

As I have quoted several times, I remember Mario Draghi saying these words at the BIS a few months ago:

"In the last half century central banks have come a long way in how they approach their macro-stabilisation functions. As recently as the late 1970s, views still diverged across advanced economy central banks as to the efficacy of monetary policy in delivering price stability. Some, such as the Bundesbank and the Swiss National Bank, were already committed to using monetary measures to control inflation. But others, such as the Federal Reserve and various European central banks, remained more pessimistic in their outlook, believing that monetary policy was an inefficient means to tame inflation and that other policies should be better employed.

(...) In this context of timidity about the effectiveness of policy, inflation expectations were allowed to de-anchor, opening the door to bouts of double-digit price rises. The outcome was a phase of so-called "stagflation", where both inflation and unemployment rose in tandem.

The policy lesson that emerged from this period was that sustainable growth could not be separated from price stability, and that price stability in turn depended on a credible and committed monetary policy. From late 1979 onwards – with Volcker’s assumption of the Fed chairmanship – central banks converged towards this orientation and took ownership for fulfilling their inflation mandates. As their renewed commitment to control inflation became understood, inflation rates fell steeply in a context of improved anchoring of inflation expectations.”[14] In symphony with this vision, the paper of Martín Uribe [15] shows, by way of an intertemporal consistency model, that the strategy for reducing inflation combined with a gradual correction of the fiscal deficit encourages intertemporal social welfare. This concept is clearly reflected on the policy on exceptional sterilization of liquidity followed by our administration from the very beginning.

Let´s see the model. An intertemporal consumer with money in the utility function, a monetary market and a budget constraint for the government. I think that Martín would not debate on inflation without bearing in mind these elements (I wouldn't either). In this model, the money is closely related to the ensuing inflation. This relationship has been a matter of concern in the papers of Yuliy Sannikov, Enrique Moral Benito and Anusha Chari. None of these models could explain the inflation phenomenon without analyzing the monetary market equilibrium. The inflation phenomenon could neither be explained in the absence of a currency (we found no barter models with inflation). However, the explanations about inflation given by economists in Argentina leave out currency. That is, they construe narratives leaving out currency. In this dimension I notice the greatest benefit of this workshop. Thus, workshops like this one contribute to gain insight into the economic phenomena and—I hope—may lead the way to a change of direction and help us achieve our objectives.

Thank you.

[1] Olson, M. (1965): The Logic of Collective Action: Public Goods and the Theory of Groups. Harvard University Press.

[2] Acemoglu, D. and Robinson, J. (2012): Why Nations Fail: The Origins of Power, Prosperity, and Poverty. New York: Crown Business.

[3] Available at: http://www.bcra.gov.ar/Pdfs/PoliticaMonetaria/IPOM_January_2017.pdf (Exhibit titled Growth Accounting in Argentina 1980-2016, p. 46).

[4] Buera, F.; Kaboski, J. and Shin, Y. (2011): "Finance and Development: A Tale of Two Sectors." American Economic Review, 101(5), pp. 1964-2002.

[5] Eberly, J. and Alexander, L. (2016): “Investment Hollowing Out”. Presented at the 17th Annual Jacques Polak Research Conference at the IMF, November.

[6] See, for example: Bhagwati, J. (1958): "Immiserizing Growth: A Geometrical Note," The Review of Economic Studies, Vol. 25(3), June, pp. 201-205; Bhagwati, J. (1987): “Immiserizing growth”, in The New Palgrave: A Dictionary of Economics, (Eds: J. Eatwell, M. Milgate and P. Newman) Macmillan, London; and Johnson, H. (1955): “Economic Expansion and International Trade”, The Manchester School, Vol. 23(2), May, pp. 95-112.

[7] For more details see the Financial Stability Report, Second Half 2016.

[8] See section “Measures Adopted”on the BCRA website for a complete list of the initiatives implemented in this sense.

[9] Available here

[10] Robert Lucas, Jr. (1973): “Some International Evidence on Output-Inflation Tradeoffs”. American Economic Review, American Economic Association, vol. 63(3), pp. 326-334, June.

[11] See Exhibit ”Inflation and Long-Term Growth” in the Monetary Policy Report - October 2016.

[12] Tommasi, M. (1994): "The Consequences of Price Instability on Search Markets: Toward Understanding the Effects of Inflation". American Economic Review, American Economic Association, vol. 84(5), pp. 1385-96, December.

[13] De Gregorio, J. and Sturzenegger, F. (1997): “Financial markets and inflation under imperfect information”. Journal of Development Economics, vol. 54(1), pp. 149-168.

[14] Passage from a speech by Peter Praet, member of the Executive Board of the European Central Bank, at the LUISS School of European Political Economy, April 4th, 2016, Rome.

[15] Uribe, M. (2016): “Is the monetarist arithmetic unpleasant?”. NBER Working Paper No. 22866.

March 21, 2017

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