Javier Mieli has found the medicine for inflation in Argentina. Argentine economists are following an old recipe to cook up an antidote with which they are achieving a relatively rapid decrease in the uncontrolled growth of prices. The recipe is simple, the complicated thing is the ‘courage’ to implement it: cut public spending and organize the balance sheet of the Central Bank of Argentina almost abruptly, in order to end the vicious circle of monetary emission to finance the public deficit and pay the interest on the liabilities of the Central Bank (the Bank of Argentina created a large amount of money to pay the liabilities). Why do you have to show courage to implement it? The problem or risk is that, like almost all antidotes or medicines, they also usually have side effects. In this case, the most common is a very strong economic recession.
Why is Xavier Miley obsessed with fiscal surpluses if he knows it will destroy the economy? Balancing public accounts and restoring market confidence is almost essential to achieving healthy and sustainable growth in the medium term, even if the immediate deterioration of the economy is brutal. What is happening so far can be compared to what happens to a hamster on a wheel that does not stop spinning: the choice is either to continue rolling until unconscious or to try to stop at the risk of falling dangerously. So far, Argentina had chosen to continue rolling on the wheel, faster and faster. But Miley’s arrival represents a 180-degree turn, a ‘shock therapy’ As BNP Paribas says, according to Allianz economists, this will cause a lot of pain in the short term.
Economists at the German insurer summarized it perfectly in a recent note: Javier Miley’s administration is trying to address Argentina’s chronic fiscal imbalances through fiscal austerity measures and efforts to strengthen the country’s external position. In line with Miley’s liberal ideology, proposed measures include reducing public sector subsidies, reducing public employment and investment, and implementing tax reforms (cutting income tax and VAT). The fiscal consolidation initiative is likely to receive the support of the IMF, which praised the administration’s “bold initial actions” and sees the new package as a basis for future discussions to restructure existing programs.
“For now, these measures seem to be working: The country started the year Several consecutive monthly budget surpluses suggest that a primary surplus may be on track for the year. However, it should be noted that a large part of the adjustment in primary expenditure is due to a reduction in pension payments and salaries, and given the current stagflation scenario and high poverty rates, further cuts in spending may be difficult, warn German insurance company experts.
The pain is already being felt. Argentina’s economy is in a deep recession, which is adding to the problems it is currently facing: The threat of povertyfalling real wages, fewer public resources… However, it is also true that the results are, perhaps, coming sooner than expected. Inflation in Argentina is slowing down quite rapidly. Monthly inflation has risen from a rate of 25% in December 2023 to a rate of 4.2% in May, the lowest in more than two years. This achievement is partly the result of expectations generated by the massive cuts in public expenditure in real terms and the promises of reforms made by the Miley government.
“This can be considered a success of the Miles administration,” says Francisco Marroquin University’s He. “The new Argentine government is committed to ending inflation, and the first successes of its policies are beginning to appear.”
Surplus is important to beat inflation
Economic theory highlights that achieving fiscal balance has a beneficial effect on the market’s perception of the country’s debt (which helps reduce the interest Argentina pays on its debt) and is usually positive for the currency, in this case the US dollar. In this way, budget balance is positive in helping to reduce inflation, both due to the stability of the currency and due to the best expectations of investors about the economy in question.
Surpluses in the public accounts allow the Argentine state to collect more money through taxes, which eventually returns to the economy in the form of public expenditures (public salaries, subsidies, pensions…), which in principle works by draining or absorbing some part of the pesos that circulate in Argentina. If we look at the quantitative theory of money (by the way, it has Spanish origins), it is the excess issuance of pesos by the central bank (to monetize the fiscal deficit year after year and to pay the huge interest on the liabilities that the central bank has on its balance sheet) that is the main cause of Argentina’s massive inflation. Fiscal surpluses are a way to drain this flood of pesos.
“Among Miley’s changes, the most important is to eliminate the fiscal deficit – basically through the reduction of public spending – and to stop financing the fiscal with monetary issuance, with the aim of eliminating inflation. If we look at the cold figures (and listen to the deaf to the quality of the fiscal adjustment) Miley has complied with ending the year 2023 with a non-financial public sector (SPNF) deficit of 4.4% of GDP, after which in the first quarter the SPNF registered a fiscal surplus, the first that Argentina has recorded since 2008. The global fiscal deficit, which includes the interest paid on the remuneration liabilities of the Central Bank of the Argentine Republic (BCRA), and which closed the year 2023 at 13% of GDP, was reduced by a third at the beginning of the first quarter of 2024, compared to the same period of the previous year, ”write Ernesto Talvi and Sofia, researchers at the Elcano Royal Institute. Harguindeguy explains.
At the same time, the Miley government has been trying with relative success to restructure the central bank’s liabilities, shifting from very short-term liabilities (those that mature every day) with higher interest rates, to other liabilities with longer duration and lower interest rates. This is also important, since the daily issuance of pesos was already large enough to finance the daily interest payments on all those liabilities that were due every day and that are mostly on the balance sheets of Argentine banks.
Also with the aim of reducing this high cost, Argentina’s central bank aggressively lowers interest ratesA risky policy (since it is once again creating pressure on the peso exchange rate), but it allows to reduce the country’s financial burden.
Yes Miley gains confidence in her project in the market And as the interest that Argentina pays on its bonds has decreased, it will become increasingly ‘simple’ to maintain budgetary stability, continue to drain the peso and reduce the financial burden of the Argentine public sector. All this, in turn, will allow the peso to stabilize which will have a significant positive impact on the economy and inflation. Economic theory also highlights that a country with a depreciating currency and an economy mired in inflation is an economy in which consumption and investment decisions are inefficient. High inflation increases income inequality and harms real economic growth (discounting inflation).
Experts in Elcano Royal Institute He believes that the hardest part is the one that is being made now: a huge and painful financial adjustment. “Regardless of what one may think of the quality of the adjustment made so far, the truth is that it has already been done. And it will come at a heavy cost in terms of activity levels, family income and increased poverty. It would be a sin not to try to capitalize on the enormous effort that citizens were asked to make to eliminate inflation in Argentina. If it were achieved, it would be a historic change and it would change history.”
Despite everything, right now Argentina’s economy is still in the ICU and no one knows if it will get out of there. However, this painful shock therapy seemed to be the only hope to save the patient. Only time will tell whether Miley’s radical policies helped revive the patient or end his life.