BUENOS AIRES — Like the heat in the austral summer, inflation in Argentina is high and showing no sign of meaningful relief anytime soon. It rose from a monthly 13% in November to 25% in December and, according to the latest central bank survey, may come in at around 20% in both January and February.
The recent increase has not been a surprise. It was partially driven by two long delayed adjustments: First, a sharp devaluation (from 365 to 800 pesos to the dollar) to narrow the exchange rate parallel premium and bring export dollars to unlock imports. And an inevitable reduction of subsidies to Argentines’ utility bills, which will help trim the budget deficit, will push energy and transportation prices considerably higher by the end of February.
The problem, though, is that Argentina’s inflation surge may prove less transitory—to use a word that still haunts central bankers everywhere—than many assume. The opening weeks of President Javier Milei’s government have been defined by talk of sacrifice, of enduring short-term pain in order to achieve the medium-term payoff of price stability, a necessary condition for a healthier economy. But there are some signs that the pain may be more acute, and longer-lasting, when it comes to prices.
Inflation sparks
Indeed, the current inflationary momentum may have been fueled, deliberately or involuntarily, by design. Argentina’s central bank in December lowered real interest rates to deeply negative territory, hoping to reduce the issuance of pesos to pay for those interests—a move that pushes consumers to spend or dollarize their savings, adding to inflation and to the exchange rate premium. In addition, the early lifting of price controls, including administered prices such as health insurance or gas, frontloaded the relative price correction at the expense of inflation.
All this, combined with the lack of a price reference—the central bank is still working on its monetary program—may have led to a so-called “repricing overshooting.” In turn, the government’s resistance to implement income policies (namely, to coordinate wage and price increases along a pre-established inflation path) contributes to price dispersion and to a collapse in real wages and pensions that hits harder on the lower-middle class—especially the unregistered or self-employed workers that account for roughly 50% of the labor force.
The economic team seems confident that the ensuing economic recession, coupled with limits on passive monetary expansion and a commitment to fiscal balance, should be enough to bring inflation below the 10% inertial level of late 2023—which is, in turn, a first step to launch a more detailed stabilization plan. It is also counting on a large trade surplus in 2024 to rebuild reserves and contain devaluation expectations.
There is a risk, though: underplaying the inertial nature of backward-looking inflation.
If prices and wages start indexing to past inflation at a high frequency, a large inflation print today becomes the reference for price adjustments tomorrow: thus, inertial inflation reproduces itself in a circular way.
Moreover, if inflation persists, the December devaluation may soon look insufficient, feeding expectations of a new realignment that, in turn, would give inflation inertia a new push—ultimately leading to a stop-and-go exchange rate pattern that sacrifices the only remaining nominal anchor of the economy.
Add to that that a large portion of the fiscal plan has just been withdrawn from the Omnibus Bill currently under heated debate in Congress, and we are left with only one bullet to bring monthly inflation back to single digits in the near term: a severe—and politically fraught—economic recession.
The fiscal anchor
Milei campaigned on the promise to stabilize the economy, with two main banners: dollarization to eliminate the central bank´s misuse of money creation, and a “chainsaw” to slice public spending and address Argentina’s core fiscal problem.
Dollarization has pros and cons, which I have discussed elsewhere. For now, given that Argentina’s net stock of international reserves is negative by about $7 billion at the time of this writing, with no significant source of hard-currency funding in sight, dollarization does not appear a realistic option for 2024.
As for the “chainsaw”, spending cuts have been so far largely replaced by tax hikes: new foreign exchange and export taxes; a one-off moratorium and a tax amnesty; and a partial reversal of the sharp reduction in the income tax introduced by the previous government (and supported by Milei’s Libertarians) during the 2023 campaign. The fiscal dividend of these new levies will be generously assisted by the dilution of public wages and social spending due to the acceleration of inflation, although the final score will likely be partially offset by a decline in tax revenues due to the recession.
Crucially, most of these fiscal ingredients are short-lived. New taxes are temporary, the moratorium is a one-off affair, and the dilution reverts once inflation slows down.
The sole exception, the change in the income tax—the most organic and progressive element of the package—now seems compromised by the withdrawal of the fiscal plan. This drawback may lead the government to partially scrap tax exemptions for roughly 2.5% of GDP that largely benefit big corporates, which have been left virtually untouched, casting doubt on the fairness of the adjustment effort.
More likely, though, inflation will continue to be the residual variable, and the key political challenge.
Tough decisions ahead
So, the question remains: What if the current plan fails to lower inflation, a condition for pretty much everything else? What if the dollarization fairy is not available as a last resort? Can the government still achieve stability before the honeymoon is over?
There is a tradeoff between using inflation to narrow the fiscal deficit by diluting the service of peso debt and depressing real public wages and pensions, and reducing inflation to stabilize the economy and mitigate the regressive nature of the adjustment.
The situation relates to “fiscal dominance”, a term used by economists to refer to cases in which a growing public debt or fiscal deficit leads to an increase in inflation that “dominates” the central bank´s price stability objective—for example, when the bank prints money and transfers it to the Treasury (“monetizing” of the deficit) or when an inflation acceleration reduces debt payments in real terms (“diluting” the debt).
Argentina’s government is avoiding the former (no central bank assistance) and exploiting the latter (lowering peso interest rates while preserving the cepo). But it is also embracing another form of fiscal dominance by fueling price liberalization—and inflation, and nominal tax revenues—while keeping public wages and pensions contained.
There is, however, a potential downside to this inflation frontloading. If forecasts are correct and December’s devaluation is fully passed through to prices by April, a new exchange rate correction will be needed, which will bring on more inflation later on—and back to square one. Also, as wages start to adjust on a monthly basis and the onslaught on peso holders continues to induce a de facto dollarization of prices and transactions, the decline in the demand for pesos could drive inflation to even higher, and more unstable, levels.
The government may trust that the combination of fiscal balance and a recession should be enough to stop the inflation train. A more nuanced view of inflation would warn that the inertial component may dwarf the benign effect of fiscal and monetary policy on inflation expectations. Absent any coordination mechanism, the past may outweigh the future, pushing the train to a greater speed. At that stage, an Argentine variety of Brazil’s 1994 Real Plan to eliminate inertial inflation, an idea many economists toyed around with during the 2023 presidential campaign, may come back to the fore.
Plan for the worst
Milei has been able to focus the public’s attention up until now on the debate of a gargantuan executive order and its companion Omnibus Law, which have been largely watered down in congressional battle, while continuing to bash the so-called casta—the privileged interest groups (“casts”) outside and inside the government. Sooner or later, however, the public is likely to judge this government on its record of stability.
The fiscal anchor is not only thin and short; it is also painful, as the government has repeatedly warned. Most voters do not know nor care about the particulars of “politics as usual” and continue to support the president. However, if monthly inflation in the second semester is still in the double digits and income does not recover, this support may wane, reducing the government’s already slim margin to implement its ambitious and controversial deregulation program. A regressive stagflation coming after a five-year crisis topped with an exhausting two-year pandemic would certainly add to the social impatience.
The country’s demand for reform is genuine, and the opposition is reading the room and trying to show a constructive attitude despite some crude verbal exchanges. But failure to stabilize, or attempting to do so by imposing an unnecessary burden in a context of a very limited social space, may prove a boomerang for change.
