Javier Milei has found the antidote to inflation in Argentina. The Argentine economist is applying an old recipe to cook the antidote with which he is achieving a relatively rapid reduction in the uncontrolled growth of prices. The recipe is simple, the complicated thing is having the ‘courage’ to apply it: cut public spending and organize the balance sheet of the Central Bank of Argentina almost suddenly, to put an end to a vicious circle of monetary emission to finance the public deficit and pay the interest on the central bank’s liabilities (the Bank of Argentina created huge amounts of money just to pay off the liabilities). Why do you have to have courage to apply it? The problem or risk is that, like almost all antidotes or medications, they usually have side effects. In this case, the most common is a very strong economic recession.
Why is Javier Milei obsessed with the fiscal surplus if he knows that it is going to destroy the economy? Balancing public accounts and recovering market confidence is almost essential to achieve healthy and sustainable growth in the medium term, even if the immediate fall of the economy is brutal. What has been happening until now can be compared to what happens to a hamster on a wheel that does not stop spinning: the options are either to continue rolling until fainting or to try to stop at the risk of suffering a dangerous fall. Until now, Argentina had chosen to continue running on the wheel, also faster and faster. But Milei’s arrival represents a 180-degree turn, a ‘shock therapy’ As BNP Paribas says, it will inflict great pain in the short term, according to Allianz economists.
The German insurer’s economists summed it up perfectly in a recent note: Javier Milei’s administration is trying to address Argentina’s chronic fiscal imbalances through fiscal austerity measures and efforts to strengthen the country’s external position. Aligned with Milei’s libertarian ideology, proposed measures include reducing public sector subsidies, reducing public employment and investment, and implementing tax reforms (income tax and VAT reductions). The fiscal consolidation initiatives are poised to gain favor with the IMF, which praised the administration’s “bold initial actions” and viewed the new package as a basis for future discussions to realign existing programs.
“For now, these measures appear to be working: the country started the year with several consecutive monthly budget surpluses, suggesting a primary surplus could be on track for the year. It should be noted, however, that a large part of the adjustment in primary spending is due to a reduction in pension payments and salaries, and that further spending cuts may be difficult, given the current stagflationary scenario and the high rate of poverty”, warn the experts of the German insurance company.
The pain is already being felt. Argentina’s economy is immersed in a deep economic recession that, for now, is aggravating the problems that Argentines have been suffering: risk of poverty, fall in real wages, fewer public resources… However, it is also true that the results are, perhaps, appearing sooner than expected. Inflation in Argentina is moderating at high speed. Monthly inflation has gone from growing at a rate of 25% in December 2023 to advancing at a rate of 4.2% in May, the lowest level in more than two years. This achievement is partly a product of the drastic cut in public spending in real terms and the expectations that the reforms promised by the Milei Government are generating.
“This can be considered a success for the Milei administration. The new government of Argentina is determined to end inflation and the first successes of its policies are beginning to be seen,” they say from the Francisco Marroquín University.
The surplus is key to eradicating inflation
Economic theory highlights that achieving fiscal balance has a beneficial impact on the view that the markets have of the country’s debt (which helps to lower the interest that Argentina pays on its debt) and is usually positive for the currency, in this case case the weight. In this way, a budget balance tends to be positive in helping to reduce inflation, both due to stability for the currency and the best expectations of investors about the economy in question.
A surplus in the public accounts allows the State of Argentina to receive more money through taxes than it ultimately ends up returning to the economy in the form of public spending (public salaries, subsidies, pensions…), which in theory works as a withdrawal or absorption of part of the pesos that circulate in Argentina. If we look at the quantitative theory of money (by the way, it has Spanish origin), it is the excess issuance of pesos by the central bank (to monetize fiscal deficits year after year and pay the gigantic interest on the liabilities that the central bank has on its balance sheet) the main cause of Argentina’s enormous inflation. The fiscal surplus is a way to drain this flood of pesos.
“Among Milei’s transformations, what stands out is eliminating the fiscal deficit – fundamentally through the reduction of public spending – and stopping financing the treasury with monetary issuance with the aim of eradicating inflation. If we look at the cold numbers (and listen deaf to the quality of the fiscal adjustment) Milei has complied After closing the year 2023 with a non-financial public sector (SPNF) deficit of 4.4% of GDP, 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 interests paid on the remunerated liabilities of the Central Bank of the Argentine Republic (BCRA), and which had closed the year 2023 at 13% of GDP, was reduced to the third starts in the first quarter of 2024, compared to the same period of the previous year,” explain Ernesto Talvi and Sofía Harguindeguy, researchers at the Elcano Royal Institute.
At the same time, the Milei Government is trying with relative success to reorganize the central bank’s liabilities, making a change from some that had a very short duration (they matured every day) with high interest rates, to others with longer durations and lower interest rates. This is also key, since the daily issuance of pesos was already large just to finance those daily interest payments on all those liabilities that fell 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 has aggressively lowered interest ratesa risky policy (since it is once again generating pressure on the peso exchange rate), but it allows the country’s financial burden to be reduced.
Yeah Milei gets the market to believe in her project and the interest that Argentina pays on its bonds is reduced, it will become increasingly ‘simpler’ to maintain budgetary stability, continue draining pesos and reducing the financial burden of the Argentine public sector. All of this, in turn, would allow a stabilization of the peso that will have important positive effects for the economy and inflation itself. Economic theory also highlights that a country with an impoverished currency and an economy mired in an inflationary crisis is an economy in which consumption and investment decisions are inefficient. High inflation aggravates income inequality and damages real economic growth (discounting inflation).
The experts of Elcano Royal Institute They believe that the most difficult part is the one that is being carried out now: a huge and painful fiscal adjustment. “Regardless of what one thinks about the quality of the adjustment made so far, the truth is that it has already been made. And at an enormous cost in terms of level of activity, family income, and increase in poverty. It would be “It is a sin not to try to capitalize on the gigantic effort that was asked of the citizens to knock out 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 the only hope to save the patient. Only time will tell if Milei’s radical policies served to revive the patient or end his life.
