Begun, the War on Inflation has
Begun, the War on Inflation has
There's somethin' happenin' here / But what it is ain't exactly clear
If you follow me on Twitter (@monetaristmaia), you know that the last week has been focused on one topic: the war on inflation.
Regardless of all the funnies (there’s been plenty), what actually is the war on inflation? Will it work? A: stupid, and no.
Nobody's right, if everybody's wrong
What did the government announce (on a Friday, at 8:40 pm)? Basically, the stated intent was to “stabilize inflation”, not even reduce it, and mainly targeted at the price of bread. The main policy announced was the creation of the “Wheat Stabilization Fund”: to prevent “profiteering” from the Russia-Ukraine situation, the authorities have increase export taxes on soy (?) and used the revenue for a trust that will stabilize the domestic price of wheat, aka subsidize wheat for no apparent reason (more on this later). There also was a series of other, even less ambitious announcements, such as a “Vegetables Fund” of uncertain funding, demands to bring prices back to February levels, and a proposed wage and price agreement.
This is all small potatoes, and I think everyone half serious can immediately tell that this isn’t an ambitious plan, a workable plan, or even very different from the policies announced and implemented in 2021 - a year when inflation accelerated from 37% to 51%. There have been threats to escalate the “fight on speculators” by using laws such as the Provision or Defense of Competition Laws, neither of which seems like it would do much except punish companies that raise prices beyond whichever arbitrary limit the Commerce Secretary sets.
But basically: what’s the rationale here? The Vegetables Fund is simply because the price of vegetables has increased remarkably in February, by 30% to 73% depending on the area. Similarly, the price controls are just to (not successfully, ever) control prices. The wage component is more interesting, and I’ll go in further detail about it later. The export controls are the silliest part. Fewer exports result in fewer central bank reserves - which, as I’ve spoken about in a previous post, is really bad and would probably be very inflationary.
But what about the inflationary effect of an increase in the price of bread? I wrote about this here (in Spanish) but brief English recap. First, since the Invasion of Ukraine began on February 26th, and the biggest commodity price hikes happened days later, it’s basically impossible for the increase in bread prices to follow from there. Secondly, bread and similar items increased 5.8% a month, verus 7.5% for all food and beverages and lower than, say, the 10.4% in fruits or the 32% in vegetables. Even then, the effect of the full price increase will not be particularly inflationary: discounting export taxes (12%), only about half of all wheat is exported. Likewise, wheat prices only make up 13% of the price of flour, which only makes up 7.5% of the Consumer Price Index. Ergo, an increase of 10% in the international price of wheat would only add 0.56% points to inflation, and around 0.5% when considering export taxes. Since inflation was 51% in 2021, a scenario where wheat prices double sustainably throughout the year only brings inflation to 56%… only one point above the expected level for the year, per the Central Bank’s survey of forecasts.
What are the consequences of this move to control prices by reducing exports? Well, there’s an upcoming harvest starting in April - and it’s very likely that products with more controlled prices, such as wheat, are simply phased out for others that aren’t such a pain to sell internationally. It’s also worth pointing out that the cost structure of farming could accelerate this move, since Russia is a major supplier of fertilizers across the globe. Either way, increased controls right before the start of the actual wheat planting season are probably very likely to shift decisions away from supplying it, ergo making the problem worse to begin with. Not to mention, the history of Argentina’s “price stabilization” boards is not great: during their hayday in the 1940s and early 50s, they only managed to shift production away from the most demanded products, while also creating a colossal fiscal burden for the government once prices dropped - while total inflation between 1943 and 1955 was of 448% (roughly 37% per year).
Even if this doesn’t happen, the inflationary effects of reduced exports are probably greater than the deflationary effects from increased domestic supply. In a small, open, inflationary economy, the nominal exchange rate acts as an anchor for inflation expectations. The Central Bank knows this, so it frequently intervenes in said market to stabilize it and ergo manage expectations. It does so by buying and selling dollars from its international reserves. Argentina’s Central Bank operates almost exclusively as a seller; it gets basically all of its reserves from exports. Net liquid reserves (aka the ones it actually has access to) are roughly 1.5 billion. A smaller trade surplus would mean fewer reserves, which would logically result in a bigger devaluation - and ergo higher costs for dollarized products, and higher expectations in general.
(Un)Fortunate Sons
So what happens next? Obviously none of this will reduce inflation, not in the long term and probably not in the short term. But the really interesting component here is the “price-wage agreement”. What even is that? Well, basically it’s a combination of price controls and wage controls.
The reason why price-wage agreements are interesting isn’t that price controls are going to do anything (so far they haven’t, and it’s becoming increasingly clear they won’t), but that wage controls might. What’s the rationale? Basically, wages are by far the largest cost that companies face - in the US, it makes up around 60% of costs. Keeping wages, particularly public sector wages, below the headline inflation rate (the government is insisting on setting wage agreements at the 45% level) could act as a disinflationary tool. Of course, this obviously comes at the expense of real purchasing power, which would decrease around 5% if inflation was the predicted 55%. Wage controls, in general, are the actually disinflationary part, and price controls are a political tool to make them politically appealing. Per Scott Sumner:
The dirty little secret of wage/price controls is that the government’s actual objective is to control wage growth, and the price controls are a fig leaf added to make the policy seem more “fair”, thus making it more politically feasible. The UK government was more honest than most, calling them “incomes policies”.
The wage controls bit follows a more generalized problem in the government’s macroeconomic policy: not everything can go up. If you promise unions that wages will go up, and promise the IMF that real regulated prices and the real exchange rate goes up, since all three represent costs for companies, then the only way to square that is with higher, not lower inflation. But nobody wants higher inflation!
The only actual solution, then, is to have someone “pay” for the disinflation - aka having one of real wages, real regulated prices, and the real exchange rate go up. 2023 is an election year, so an exchange rate anchor is out - it would imply a balance of payments crisis by the end of the year, since the Central Bank’s has a dismal amount of firepower, and probably even higher inflation in 2023. Normally, the authorities would choose to pay for the disinflation by letting real utilities grow even cheaper, but 1) they promised the IMF a real reduction (mainly as a way to slash the deficit), and 2) the increase in international natural gas prices would mean that the deficit would grow significantly in real terms - since subsidies would be larger to maintain the same real price. Ergo, wage compression is the only way to really accomplish an actual stabilization of the inflation rate. It’s also a way to reduce the disemployment effects from a disinflation, since it involves shrinking aggregate demand - the adjustment either happens in quantities (i.e. by laying off workers) or in prices (by paying them less in real terms). Politically, money illusion ensures that the second path is less painful - though it does seem that the President and his party have all but admitted they will not win a second term next year.
Conclusion
To quote a famous song: “War / What is it good for? / Absolutely nothing”. The war on inflation, besides from all the memes, does not seem like it will contribute anything meaningful to macroeconomic conditions besides even more distortionary policies to unwind when reasonable policymaking is back on the menu. The government’s fundamentally confused approach to inflation, if they even have a consistent one at all, has not yielded any successes in the past year, and by now it is self-evident it will not either in the next year. A successful disinflation would require sustained monetary prudence, an unwinding of long-standing distortionary policies, and a real reconsideration of what fiscal policy ought and ought not to do. Any less will simply not suffice - not when the 60% mark has become a tangible possibility.