(Expansion) – A few days of COVID-19 put everyone’s integrity to the test, since the persistence of some symptoms tires. For example, they have led me to think about something that I know makes no sense: if I double the dose of the medication, won’t this ordeal end faster? I think I’m not the only one.
Our understanding of cause and effect is called into question when it involves our well-being. That is why the sick person receiving treatment is called a patient.
It occurs to me that something similar happens with inflation, that other disease that afflicts the world. The most recent annual rate readings for the general rate in Mexico and the United States are at 8.2% and 8.9%, respectively, levels not seen since the beginning of the century in our country and in 40 years in our northern neighbor.
In addition to the level, there is concern about persistence. At the end of 2021 (with inflation of 7.36% in Mexico and 5.5% in the United States), the perspective was that its determinants would gradually dissipate. This has not happened and central banks have been forced to react.
The change in position is more notable in the case of the Fed than in that of Banxico, since it goes from a benevolent view of inflation as a transitory phenomenon to increases of 75 bps in its reference rate, which it will most likely repeat in its meeting of this week.
Now that there is apparently a consensus to increase rates and do so significantly, the risk to avoid is to overmedicate ourselves. Going from increases of 75bp to 100bp without having evidence of the impact to date of the more restrictive stance and above all, with a still confused diagnosis of the determinants of inflation could be counterproductive. It sounds, in my opinion, more like monetary machismo than a reinforcement of credentials.
The US car market offers a good example. In the 38 years between 1982 and mid-2020, the price of used vehicles increased 35%. In the following two years it rises 50%. What happened? Essentially, supply shocks – production drops during the pandemic and from mid-2021 due to restrictions on electrical components – that still keep sales lower than they should be. The ratio of inventories to sales, historically a multiple of 2, remains at levels of 0.5. There are very few cars for sale and therefore the ones that are available cost more.
In the circumstances described, a very aggressive increase in rates can effectively limit price increases by severely weakening demand. But if the original problem is supply constraints, the result – lower inflation – is obtained at a substantially higher cost in terms of output.
It’s the difference between returning to domestic US auto sales of more than 18 million vehicles a year or capping them at current levels of 13 million. It is clearly a decision of the greatest importance for our country.
We are, to some extent, victims of our success. At the end of 2021, 17 of the 20 G20 economies showed activity levels higher than those prior to the pandemic (Mexico is one of the exceptions). This involved aggressive stimulus programs and eventually inflation, both in financial assets – no one complained about this – and eventually in goods and services.
Obviously it has to be addressed and the action of central banks is crucial to prevent some of these macro-adjustments in relative prices and price reactions that had remained inert for a long time from becoming endemic.
Nobody has the last word on this, but I would wait to see the reactions to the 75bp doses before thinking about even more aggressive rate increases. In particular – and I believe that on this front Banxico can improve even in what has been a reasonable performance – it is necessary to nurture the patient’s patience by better communicating the type of treatment and the strategy to follow.
Editor’s Note: Sergio Luna studied Economics at UNAM and the University of London. He was an economist at the National Bank of Mexico for 33 years and continues in that profession, now independently. Follow him on and/or on . The opinions published in this column belong exclusively to the author.
