Javier Milei's proposal to abolish the Argentine central bank suggests that it is backed by the need to address "a serious issue of credibility" with the local currency.

December 20, 2023 15:44

The inflationary period that Europe and the United States have been going through since early 2021 was initially seen as driven by technical and temporary factors, but in reality, we must find the underlying reasons in the "activism in monetary policy" of modern central banks, according to Juan Castañeda in his talk "Models of Central Banks and the Price of Their Mistakes", offered at the University of the Hespérides, where not only proposed explanations for the current crisis but also made a brief review of these entities throughout history and addressed Javier Milei's initiative to eliminate the Central Bank of Argentina.

In 2020 and 2021, the pace of money growth tripled, from the usual 4% to 12%, three times more than normal "and they thought this wouldn't be inflationary," said Juan Castañeda, who believes initial estimates failed by using "macro models" that don't take into account the amount and demand for money when estimating what will happen with inflation in the next few years. This is what happened with the projections, the range of estimates, which in the case of those formulated in 2020 and 2021 didn't even manage to calculate the inflationary escalation "not even within the worst possible scenario."
Throughout his presentation, he cited Vera C. Smith as a key figure in the study of the origin of central banking, as highlighted in her book The Fundamentals of Central Banking and Free Banking. This text reveals "the fundamental alliance between a newly created bank and a state seeking financing," an alliance that is repeated in the creation of modern central banks, where a new private bank "gets the privilege of issuing currency in exchange for financing the government."
This relationship between central banks and governments, backed by the gold standard, had limitations on emissions, as any user could exchange that money for its equivalent in gold. It was a central banking model in effect from 1813 to 1913, which maintained price stability over time, because the central banker's ability to print bills was limited, which contributed to preventing significant fluctuations in price levels. This differentiates them from today, where central banks have "an active intervention in productive economy," while during that period it was sought that money would not interfere with real economy.

In your opinion, the crucial difference between historic central banks and modern ones is that current ones are purely fiduciary. There's no effective limitation on their ability to issue money, and monetary rules are lax, allowing for considerable discretion. Therefore, since the 80s, models have focused on 'stabilizing the cycle' and fiscal dominance, where it's expected that the central bank intervenes to support the state in times of crisis, either implicitly or explicitly financing the debt issued by states.

Very much tied to the core of his speech, Javier Milei's proposal to abolish the Argentine central bank is based on the need to address "a serious credibility problem" with the local currency, characterized by annual inflation rates around 140%. Dolarization then presents itself as a strategy to "import" that credibility through the US dollar.

The abolition of the Central Bank of the Argentine Republic would be a measure "to send a clear signal" that this approach will become an essential element of the country's new economy, by setting a direction that is "irreversible". The intention is to avoid the possibility of a return to previous economic practices and not only stabilize the currency, but also establish "restrictions that prevent excessive government borrowing".