The fiscal anchor against lethal adjustment and monetary mirrors

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Dollarization and other currency reforms offer shortcuts that lead to a bad port. Argentina has a fiscal dominance problem. Therefore, the solution involves a fiscal peg. What is a tax anchor? Is this the same as a simple tax adjustment? It is difficult to give a good answer to these questions. But the success of the 2024 stabilization plan depends on this.

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Let’s start with the monetary domain, which is much more common. This is the moment when no one is in any doubt that the Central Bank wants low inflation and that no politician will interfere with that goal. Specifically, it is when there is a belief that policymakers will change fiscal policy as much as necessary to meet the low inflation target. Thus, announcements from the Central Bank (such as the price of the dollar, inflation targets, etc.) act as a “monetary anchor”.

What does it mean for something to function as a monetary anchor? A simple version is that people sign their contracts assuming that inflation in the near future will really be the one announced by the Central Bank. The classic counterexample is that of a government seeking help from monetary policy to expand the economy just before an election. Some countries have made institutional changes to make such interference more difficult. An example is when they appoint the president of the Central Bank for periods that do not coincide with presidential periods. The same idea, but more extreme, is when the central bank is granted “independence”. The American case of 1979 is interesting: the Central Bank was not very independent but the Democratic president (Jimmy Carter) chose a technocrat with a conservative reputation (Paul Volcker had been part of the administration of the Republican president Richard Nixon). And Volcker paid off because he raised rates (and unemployment) in the midst of Carter’s re-election campaign.

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The fiscal domain is different because the inflation included in the contracts comes from predicting what fiscal policy will do. In Argentina we know that we always go to waste due to fiscal indiscipline, which forces monetary policy to go crazy. The key, then, is predicting politicians’ commitment to fiscal seriousness and whether “this time it’s for real.” In these cases it is useless to have a monetary peg. The reason is simple: People’s focus when forming expectations is expected fiscal performance, and this is unaffected by monetary policy goals.

Why should putting a monetary anchor, through the dollar or an inflation target, change how we think about politicians and their tendency to run deficits? Wouldn’t that be like carrying a spare tire to someone who has run out of gas? Of course you may need it later, but your problem today is another. Maybe in the 90s some minor politicians were convinced not to spend too much because there was convertibility. But the past twenty years have shown us that politicians no longer respect those limits, perhaps because they consider them artificial. The politician who will be able to stabilize is the one who will be fiscally “serious” by conviction and not by “rule” self-imposed demands it. There are cases where the monetary anchor works for a short time, but usually exacerbates the problem (because the calm allows them to borrow to keep spending). This is the the monetary anchors in a situation of fiscal dominance are “bread for today, hunger for tomorrow”.

Since the anchor is fiscal, the question is how to make it compatible with low inflation. The answer lies in recovering the most basic attributes of the state, such as its “capacity” (what is sometimes called the degree of government) and its “autonomy” (which in this case means a state free from the meddling of of interest). Of course, it is not enough to announce a simple fiscal adjustment. To see this, let’s imagine a big fiscal adjustment made by a minority or internally dissenting party. Wouldn’t a little adjustment made by a “helmet party” who cares about “14 tons of rocks” be much more believable? The slogan would be: we need a strong state (capable of shrinking when necessary) more than a small state (which finds it hard to change). I confess a preference: it seems to me that the Argentine state must also shrink because the tax burden is excessive and it is impossible to grow by expelling entrepreneurs. But I admit that a large state capable of producing fiscal surpluses at will is unlikely to fall into fiscal dominance.

Can institutions be developed to support the credibility of the fiscal anchor (equivalent to the independent central bank)? It looks difficult. We had some attempts at tax rules, but they were easy to break. Perhaps a tax czar (played by a right-wing politician?) who did this can be named the same role as a Volcker-style conservative central bank president. But it would be much better if the new president had it a structural reform plan that gives the key signal: fiscal discipline is just one of the many costs that we are willing to pay to debunk the myths that immobilize us. It is possible that the reforms will also help by increasing the supply of goods and services. But the great merit of the government facing a “storm of structural reforms” is that it will become the one who manages the political agenda of the country, overshadowing any protests from the sector.

There is no escaping the central conclusion: we have fiscal dominance because the main source of uncertainty in the economy is the erratic behavior of a state which does not belong to us and which must be financed as it pleases.

In summary:

1. We suffer from fiscal dominance, so what we need is a fiscal (not monetary) anchor.

2. A simple fiscal adjustment may not serve as an anchor. For example, why people might interpret it as implausible. This risk may increase when monetary anchors are announced.

3. Reforms aren’t that important if we just want to make a simple fiscal adjustment. But they are crucial if we are looking for an anchor because we want government to set the agenda.

4. Tax institutions can help make adjustments. But an anchor requires a tax czar whose hands are not tied.

Source: Clarin

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