The “suppressed inflation” hypothesis and catastrophic forecasts

Economics is not an exact science and economic analysis is based on different hypotheses about the functioning of the economic system, which are later endorsed or rejected through empirical evidence. This methodology is similar to that used in medicine, meteorology and other sciences and, as in these, some hypotheses occasionally lead to the posing of catastrophic forecasts, which fortunately do not usually materialize.

Recent examples of extreme hypotheses in the economic field include the numerous hyperinflation forecasts made for Argentina in 2020, the prediction regarding the end of capitalism and the consequent need to change the way of thinking about the economy after the international financial crisis of 2008-2009 -although it was anticipated with traditional analytical instruments-, the recent announcement about the imminent collapse of the dollar in 2021, or Steve Hanke’s analysis that inflation rates are poorly measured in many countries, and that particularly in Argentina it could rise to 120%.

Although each of these forecasts deserves an individual analysis, in this column I will focus exclusively on the analysis of the last one, given its importance in the current debate on inflation in the country.

Hanke bases his analysis on the idea that the so-called Purchasing Power Parity, measured at the implicit exchange rate in open market operations, has to return to equilibrium levels, which will occur through price increases to the extent that the “repressed inflation” is recognized. History shows that this does not always happen this way, while it is very difficult to define an equilibrium value. To clarify this concept is worth an example.

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The cost in dollars of a taxi ride from my house to downtown is currently around $ 2.50. However, over the last 40 years it ranged between $ 1.50 and $ 12, averaging $ 5.

The hypothesis of “repressed inflation” assumes that the current price of the dollar in alternative markets is correct, and that the price of the trip has to return to its “historical” values ​​through increases in its price in pesos. If the calculation is made at the official exchange rate, the current price is around 4 dollars, closer to the historical average.

The idea of ​​”repressed inflation” is recurrent in Argentine history. There are always prices that are below their historical averages, while all sectors aspire to recover their historical highs. Unfortunately, this desire is impossible to occur since the sum of the aspirations of all sectors far exceeds the country’s GDP, it triples it.

However, the successive sectoral attempts to recover their best relative prices – which reminds me of a “merry-go-round” of relative prices – is one of the factors that puts pressure on inflation. Let us analyze as an example what happened with wages.

The purchasing power of the registered salaries presented important fluctuations in the last 25 years, which were even greater if the analysis is carried out in dollar terms. The average for the 1995-2020 period is very similar to the level reached on a specific basis in 1995 and 2020.

However, the lowest purchasing power was recorded in 2003, resulting in the same 28% lower than the average purchasing power of the period. At the other extreme, the highest purchasing power was registered in 2015, at which time real wages were 20% higher than the average for the period, while being almost 70% higher than the 2003 minimum. The growth in real wages is compatible with the negligible growth in per capita GDP during the same period.

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Observing these values, it should not be surprising that workers try to recover the levels of 2015 (defending joint agreements with “trigger” clauses), while employers yearn for the levels of 2003 (arguing the need for a “higher exchange rate”). competitive”).

However, any attempt to return to one extreme or the other will necessarily be reflected in significant price increases in other sectors, since they would be attempted by moving nominal variables, wages or the exchange rate.

Now, what happens with the purchasing power of wages will ultimately depend on the reaction of other sectors of the economy to these nominal movements. The level of real wages does not depend on the wishes of workers, employers or authorities, but is determined by the general conditions of the economy.

Examining the evolution of the main components of the price indices, we observe that all “real” prices are currently below their maximum values, while almost all are above their minimum.

Food being those that are closer to their maximums, while rates are closer to their minimums. In this context, the vast majority of sectors feel entitled to demand a “recomposition” of prices, which generates inflationary pressures when they try to achieve it.

Recurring inflation is one of the great evils of the Argentine economy. As Fernando Marengo aptly titled in his recent column, “inflation is the result of the political and economic failure of our country”. If we want to improve the well-being of Argentines we must eradicate it.

As I emphasized in several previous columns, inflation is a complex phenomenon that involves monetary, fiscal, exchange rate and indexation factors, a reflection of the struggle between sectors for income distribution.

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To end this scourge, all these factors must be stabilized simultaneously; if we don’t, inflation will accelerate and our country’s decline will continue.

Ricardo H. Arriazu is an economist.


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