A Letter to the Politicians of Argentina Regarding Inflation

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Figure 2: The Inflation Gap

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(Source: The Economist 2012)

In addition to this, since its 2001-02 economic collapse, the Argentinean government has been adopting an expansionary fiscal policy; however, this unfortunately results in a worsening situation with regards to inflation. Normally, it is reasonable for the government to increase spending and levy lower taxes in order to aggregate demand in times of recession. However for Argentina, inflation has been a constant problem – total demand has always surpassed total supply. Therefore, by adopting expansionary policies, Argentina’s supply is becoming further outpaced by the increasing demand. This is what Robert J. Gordon defines as demand-pull inflation (2011). To resolve this problem, contractionary fiscal policies should be implemented; which would mean decreasing government spending via austerity measures, and increasing tax rates.

Argentina’s many failed anti-inflation policies have led to lowered public confidence in its monetary system, whilst the negative interest rate has further discouraged people from depositing money in banks. These two factors jointly breed a consumption culture in Argentina, leading to a surplus in demand. Hence, it is imperative that the Argentinean government builds a credible monetary system, which would encourage people to deposit money in banks, decreasing the amount of money in circulation and eventually bringing down inflation.

Finally, large wage increases granted by the Argentinean government to combat inflation have led to higher inflation rates. It is understandable for the government to moderately increase wage levels so that citizens are still able to afford goods and services. Nevertheless, the overwhelmingly generous wage increase at approximately 20% per annum (Kiguel 2010) significantly increased labour costs for firms. The effect of this is for employers to naturally shift the burden to buyers in the form of higher prices, ultimately resulting in higher inflation rates. This price/wage spiral effect is a manifestation of Gordon’s “build-in inflation” model (2011). The government should raise wages in line with the actual price level; instead of to a level which is aimed to please voters in order to win political support.

(Word Count: 1,181)

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