Inflationary Confusions and False Exits

Inflation is the continuous increase in the general level of prices. This notion has two implications: inflation does not consist of the general level of prices, but of their rate of growth, and it does not refer to relative prices, that is, to the prices of some goods and services relative to others.

At any latitude, sooner or later, high inflation occurs because the growth of aggregate demand significantly exceeds that of aggregate supply. Furthermore, when the country has a flexible exchange rate regime, this imbalance is ultimately supported by an accommodative monetary policy.

In Mexico, the general level of consumer prices is measured by the INPC, calculated as a weighted average of the monthly quotations of thousands of prices of a sample of thousands of products and services, grouped into 299 generics.

Our country suffers from high inflation. In April 2022, the annual variation of the INPC reached 7.7 percent, the highest rate since January 2001. Inflationary pressures were widespread: more than 80 percent of generics registered annual increases in their prices above 4.0 percent.

Likewise, the trend of inflation has been upward. The annual variation of the core subindex of the INPC, which excludes agricultural and energy items and tariffs authorized by the government and, therefore, marks the medium-term trend of inflation, accumulated 17 months of continuous rise last April, reaching 7.2 percent, also the highest since early 2001.

Since March 2021, Banco de México’s monetary stance has been unusually expansionary, reflected in the fact that, unlike previous restrictive cycles, the reference interest rate, although it has risen, has been persistently below of annual inflation, thereby facilitating the transit of inflation.

Despite these facts, the public debate on inflation in Mexico suffers from multiple confusions. A common mistake is to identify the level of some prices with the dynamic process of inflation, arguing that inflation is generated by factors equivalent to taxes, such as low competition in some sectors and the ‘surcharge’ of goods due to the effect of delinquency.

Another error lies in maintaining that inflation is imported and there is no excess demand. Such assertion reflects a predetermined exchange rate reasoning, where domestic inflation is determined abroad. In contrast, in April 2022, the annual variations of the INPC components, ‘services’ and ‘other services’ without direct links with the outside, reached 4.8 and 7.0 percent, respectively, which confirms internal demand pressures.

The Package against Inflation and Famine (Pacic), announced last week by the government, exhibits similar confusions. At least six of the 16 measures appear to obey the circular observation that “inflation rises because prices rise.” Four of them, notably the ‘stabilization’ of energy prices and private participation, seek to contain the increase in some prices, while the other two seek to reduce the level of other prices.

The rest of the measures are intended to increase production and facilitate the importation and transport of goods, through ongoing spending programs or actions such as road safety surveillance, which should be expanded and made permanent.

As has been the case with infrastructure packages, the Pacic could be ineffective. In seeking to counteract some symptoms, the inflationary impact is likely to be negligible. In addition, since most of the committed resources will continue to be channeled to the gasoline subsidy, it is not aimed at supporting families in poverty.

Finally, contrary to popular belief, the Pacic is not heading in the right direction. The main risk is complacency, by favoring measures that try to ‘repress’ inflation and accumulate costs for the future. In 2017, Mexico experienced an inflationary exacerbation derived from the unsustainability of gasoline subsidies.

The danger is not theoretical, but real. In his comments to the Pacic announcement, the President of the Republic expressed his desire that the Bank of Mexico not continue to increase its interest rate.

The task of combating inflation falls to Banxico, which is autonomous. The idea that the Pacic has lightened this responsibility would be a regrettable illusion, which would weaken the perception of the central bank’s commitment to price stability.

The author is a former deputy governor of the Bank of Mexico and author of Mexican Economy for the Disenchanted (FCE 2006).