The Shots Heard Round the World
Why conservative economists are aghast at radical reforms by Argentina’s central bank.
At a time when most governments seem incapable of doing anything about unemployment, worsening economic inequality, and continuing financial instability, Argentina has adopted a set of striking new reforms that will enable its central bank to play a much more proactive role in addressing all of these problems. In fact, the reforms, adopted in March, may be the first shots fired in a quiet revolution in monetary policy. If successful, they could threaten to overturn 25 years of conservative central bank policies that have long been considered best practice by the IMF and central banks around the world.
Argentina’s new central bank president, Mercedes Marcó del Pont, said the reforms challenge the conservative axiom that central banks should play a very limited role in the economy. The bank is now rediscovering its sovereign capacity to formulate and implement economic policy, she explained, adding that some of the portraits on the bank’s hall of fame would be coming down — "beginning with Milton Friedman’s."
Stalwarts of free markets and "central bank independence" were aghast. The Economist proclaimed that the Argentine central bank had become the "piggy bank" of the government, "losing the last shred of its legal independence." It claimed the government’s meddling in the central bank would lead to reckless fiscal deficits and spark out-of-control inflation. Similarly, The Wall Street Journal‘s Mary Anastasia O’Grady reported the state had "stormed the central bank… destroying the last vestiges of independence," and told its readers to "Cry for Argentina."
Launched by President Cristina Fernandez de Kirchner and approved by Congress, the reforms formally abandon the central bank’s focus on maintaining low inflation to the exclusion of other economic goals. From now on the bank will pursue a triple mandate of monetary stability, financial stability, and economic development.
In other words, rather than merely fighting inflation, the central bank will now play a broader role in economic management. It will safeguard financial stability through the application of corresponding regulation and it will promote job creation and more equitable development through the allocation of subsidized credit to priority sectors. The shift requires the central bank to coordinate more with government policies and priorities — a radical step away from the 25 years trend of "central bank independence."
A key reform enables the government to use more of the central bank’s $47.3 billion in international reserves for servicing external debt payments, which would enhance Argentina’s creditworthiness. Previously, the bank was required to have a high level of reserves, but now the central bank’s board decides what level of reserves is consistent with its monetary and exchange-rate policies.
A second reform gives the central bank an increased role in supervising the financial system by regulating domestic credit conditions, including loan maturities, interest rates ,and commissions, and preventing excessive risk-taking. A third reform allows for increased central bank help to the government for financing domestic banks and institutions involved in job creation and productive investments.
Supporters say the changes will help Argentina address its diminishing fiscal and trade surpluses in the short term. But more importantly, it will allow for greater financial stability and the use of incentives and disincentives to steer investment capital and loans toward businesses and projects that increase jobs and boost domestic production. Critics say the reforms will lead to over-regulation that will constrain finance, and worry that the government will go too far with new spending.
The changes break a host of taboos in the dominant school of monetarism in neoclassical economics and conservative policy circles — a bold effort to show that central banks can play more proactive roles by providing credit to promote productive investment and job creation, and doing so with an eye to ensuring greater socioeconomic equality.
Such interventionist policies have been rare in recent years. In the 1970s, the financial services industry complained that interventionist central banks were too easily "captured" by populist governments who recklessly increased public spending in order to get re-elected. They famously complained that too much central bank financial oversight was constraining investors’ "animal spirits" and amounted to "financial repression," prompting leaders such as U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher to promise liberalization reforms and "independent central banks."
This began the trend in the 1980s of IMF loan conditions and policy advice that pushed central banks to make decisions in increasing isolation from the fiscal demands of governments — and thus from voters’ preferences. Over the last few decades, low inflation became the leading goal of monetary policy, regardless of what else might be happening in an economy, and any fiscal policy goals had to be constrained to accommodate it. In other words, monetary policy came first, and fiscal policy goals were second. The financial sector benefited from the low inflation and the greater degree of freedom to invest capital in speculative activities afforded by deregulation, but government-spending and public investment consequently suffered.
Argentina’s dramatic turn will now allow fiscal policy goals to lead, while monetary policy takes steps to accommodate it. But even after 25 years of having their way, economic conservatives disagree with the new tactic; Abel Viglione, an economist at the Bueno Aires free market think tank Fiel, objects to the new mandate precisely because it once again subordinates monetary policy to fiscal policy.
In response to her critics, Central Bank President Marcó del Pont denied that printing currency necessarily leads to inflation, especially when inflation is rooted in other causes. While monetarists may view inflation as primarily the result of too much money in circulation, Marcó del Pont argued that economists should also consider additional sources of inflation, such as bottlenecks in supply routes or external factors like price hikes on international markets — factors that have been known to spur inflation in Argentina and other countries like it. In such cases, simply raising domestic interest rates — as the IMF often demands — does little to solve the root of the problem. What’s really needed, in many cases, is increased public investment targeted at clearing up supply bottlenecks or buffering against external shocks.
Yet it is precisely such increased public investment that is often discouraged by the IMF, which claims that rising fiscal deficits will lead to higher inflation and crowd out more efficient private sector investment. Others point out there is little evidence that deficits lead to higher inflation, and more importantly, it all depends on what exactly the governments spend: If the deficit is used to increase public investment in infrastructure, human capital, technology, and R&D — measures that will ultimately increase the economy’s future productivity (and more than pay for themselves with higher taxes over the long run) — such deficit spending should be OK. Yet critics of this approach worry the government will squander the expenditures on unproductive investments or wasteful consumption, only adding to the debt burden.
According to economist Gerald Epstein, co-director of the Alternatives to Inflation Targeting Project at the Political Economy Research Institute of the University of Massachusetts Amherst, the Argentine reforms are in line with the historical practices of many central banks. In both industrialized and developing countries, central banks were historically more integrated with governments on macroeconomic policymaking, even coordinating credit allocation policies with them. Epstein cites several successful economic recoveries after the Second World War that were based on such collaboration, including examples from South Korea, Taiwan, China, and India.
It will be interesting to see whether Argentina’s reforms inspire other countries to adopt similar changes, thus bringing about a sea change in monetary policy around the world. International enthusiasm for Argentina’s reforms is building: economists in the UK, the U.S., Turkey, and elsewhere have been sending letters of support. Epstein, a signatory to the U.S. letter, says: "I hope other countries will look closely at the Argentine experience and be inspired to go down a similar path: To transform their central banks to act less as agents of finance and instability and more as agents of equity promoting economic development."
Less enthusiastic about such prospects are champions of financial liberalization, such as those at The Economist and The Wall Street Journal, and at least two generations of economists who’ve built their careers on the efficacy of central bank independence. In queries for this report, the IMF press office would only say, "No comment."