I would like to start by extending a warm congratulation to the Bank of Mexico for these first twenty-five years of autonomy. But I would like to go further. The celebration should not be limited to the birthday itself, but should include all those years of a continuous, effective, responsible and successful exercise of autonomy.
During that period of time, the Bank has acted scrupulously, having implemented a monetary policy aimed at achieving the priority objective set by the Constitution, 1 to ensure low and stable inflation. Moreover, the policy measures adopted by the Central Institute have always observed the key limitation that the Constitution also indicates, in the sense that it cannot extend inflationary financing to the Federal Government.
The results have not been delayed. Over the years, since the autonomy of the Issuing Institute came into effect in 1994, inflation in Mexico has shown a significant reduction, as has its volatility and persistence. These achievements, together with a well-communicated monetary policy, have resulted in an effective anchoring of inflation expectations at levels close to the target level determined by the Bank itself, which in turn has been reflected in a reduction in interest rates Nominal and real medium and long term. The above has surely produced greater economic efficiency in the country, as lower inflation uncertainty prevails, the signals emitting relative price variations are much clearer, allowing a better allocation of scarce resources between alternative uses and in the intertemporal dimension.
This favors greater savings and better quality, which drives investment and consumption of durable goods. The end result has been higher economic growth - although not enough -, the creation of greater employment, the reduction of extreme poverty and a better income distribution.
Hence, it is said that maintaining low and stable inflation is not an end in itself, but a means to achieve complementary objectives in terms of welfare for the population. This underlines the importance of the autonomy of the Bank of Mexico and its responsible exercise.
Now, what makes the autonomy of a central bank work? This has four relevant dimensions: legal, economic, social and political. All these dimensions in principle should support each other and interact virtuously so that autonomy delivers the desired results. From the experience of the Bank of Mexico lessons can be drawn that give us light on how this virtuous process is generated. I will dedicate the rest of my intervention to expose four oral lessons that I have personally identified.
II. Four Lessons Derived from Twenty Five Years of Autonomy
First. Effective autonomy requires great social and political support.
The autonomy of a central bank is primarily a political phenomenon, as well as being a technical solution to the problem of how to efficiently achieve low and stable inflation. That is, to enshrine in the Constitution the creation of an institution within the State committed to preserving the purchasing power of the national currency is a categorical political expression of society as a whole, which reflects the importance attached to protecting the population. in general the lacerating effect of disorderly inflation. This expression is based on the collective memory about the restlessness experienced in times of high inflation, fiscal disorder and financial instability. We must remember, among other sequels, that inflation is a highly regressive tax, since it mostly affects those who have less.
One might think that the social conviction about the inconveniences of uncontrolled inflation is very strong, entrenched, difficult to change in the future. But do not trust. The central bank could be a victim of its own success. It is a great challenge to instill the aforementioned conviction in the new generations. In Mexico, approximately 35 percent of the population has not lived in times of high inflation, with two or more digits.
Hence, it is essential that the Bank of Mexico does not blind in its efforts to remind the population, and in particular the young generations, of the benefits of an economy without inflationary problems. Feeding that conviction is the best way to keep autonomy alive.
Second. The central bank must assist the government in achieving broader economic objectives, to the extent that the fulfillment of its mandate allows it.
By virtue of autonomy, the central bank, being an organ of the State, is delegated the exercise of some economic policies: the main one is monetary, but usually also includes some aspects of exchange rate policy and regulation and Financial system supervision. This delegation is aimed at achieving the priority objective embodied in the law, as well as being accompanied by a solid governance of the institution and a clear system of accountability to the Legislative Power and to society in general.
As I have already mentioned, the pursuit of low and stable inflation contributes to the achievement of broader economic objectives, such as accelerated and sustained economic growth, lower unemployment, better income distribution and poverty reduction. This could be interpreted as if the central bank had to worry only and rigidly in fulfilling its priority mandate. However, circumstances could arise in which the central bank could be somewhat flexible in helping the government to pursue better performance of the national economy, leading to greater benefits for society. If the issuing institute has the capacity to influence that way, without jeopardizing the fulfillment of its priority objective, it should act accordingly. This attitude would strengthen social and political support for their autonomy.
I am aware that the proposal is not an easy task, much less risk free. Misapplied could undermine the credibility of the central bank. Therefore, one should act with great caution and prudence. The challenge is to be able to adequately identify the circumstances in which the central bank can make a broad and flexible interpretation, but responsible for what the fulfillment of its mandate represents.
I would like to illustrate the above through three examples:
If inflation is clearly below the established target, the central bank could adopt a more lax monetary policy. This would be a sign that the central institute maintains a symmetrical attitude in response to positive or negative deviations from the inflation observed with respect to its goal.
Circumstances often arise in which, derived from supply shocks, adverse variations in relative prices can lead to increases in measured inflation. Remember that inflation is a general increase in the general price level. Therefore, in principle, the central bank may not need to respond to the scenario described by a more astringent monetary policy, particularly if abrupt variations in relative prices do not affect medium-term inflation expectations.
In these circumstances, it is most likely that the deviation of inflation from its objective is temporary, so a policy response would not be necessary. Even the impact of this policy on the economy is lagging, taking effect once the supply shock in inflation has already vanished. Credibility of the central bank and an effective communication policy would be essential to ensure a good final result.
On the contrary, there could also be episodes in which it might be convenient to adopt a more restrictive monetary policy stance, even if the behavior of contemporary and expected inflation is not misaligned with the fulfillment of the objective. Exuberance in the financial markets could predict destabilization in the future, which could have severe repercussions on the behavior of economic activity and inflation.
This circumstance could justify the adoption of a more restrictive monetary policy, in order to take away the overflowing optimism in the financial markets, even if the foreseeable inflation performance does not suggest it. In this case, in the absence of a more prudent monetary policy, there could be an inflationary surprise on a broader horizon accompanied by an abrupt slowdown in economic activity, which would certainly justify the immediate action of the central bank.
The underlying message is clear: the central bank should not have a mechanistic approach to its reactions to deviations - or the absence of them - from its inflation target. The national and international macroeconomic context is always important for a refined conduct of monetary policy, which tends to produce more positive comprehensive results for society, thus reaffirming the value of autonomy. It is my opinion that, in general terms, the Bank of Mexico has followed this pattern.
Third. The coordination of macroeconomic policies is essential to achieve low and stable inflation.
This is the logical consequence of an inescapable condition: monetary policy does not act in a vacuum. Although monetary policy is one that in principle has the greatest weight in determining inflation, other policies also affect it, as well as phenomena that do not have a strict monetary and financial profile, such as globalization and acceleration technological change. In fact, the efficiency in terms of economic growth with which low and stable inflation can be achieved is much greater if the synergies between the various economic policies are taken advantage of and if the limitations of each of them are recognized. In a nutshell, as a country you should aim to have a consistent macroeconomic framework that allows you to reach potential growth with low and stable inflation, so you should seek maximum coordination at least among monetary, fiscal, exchange rate, financial policies, Commercial and economic competition.
Both in the Exhibition of Reasons2 of the constitutional reform that gave life to the autonomy of the Bank of Mexico, as in the Bank’s own Law3, the importance of the coordination of monetary policy with the rest of the economic policies is recognized. In fact, the Bank Law itself and other laws provide for several specific instances of coordination. Among them are:
The Exchange Commission, composed of the Secretary and senior officials of the Ministry of Finance and Public Credit and the Governor of the Bank and two members of the Governing Board;
The permanent invitation to the Secretary and Deputy Secretary of the Treasury to attend the meetings of the Governing Board, with voice but no vote;
The participation of members of the Governing Board in the governing bodies of the regulatory commissions of the financial system; and
The incorporation of the Governor and other members of the Board to the Financial Stability Board, chaired by the Secretary of the Treasury.
In short, the autonomy of the central bank does not condemn it to isolation. This has become clear during the last twenty-five years. In this period an environment of low and stable inflation in the country has been consolidated. There is no doubt that monetary policy has done its part, but the results obtained also reflect effective coordination with other instances of government.
Quarter. Communication is an instrument of monetary policy, so it must be an integral part of the actions of the central bank.
For society to believe in autonomy and support it, it must first understand it. For you to understand it, the central bank must explain clearly and tirelessly what it does, how its policy instruments work, how it expects its actions to have the desired effect and what is the environment in which it operates. You should also explain to the public your limitations and what is beyond your reach. This cannot be achieved without a good communication strategy.
When the autonomy of the Bank of Mexico was designed, a predetermined exchange rate regime was in effect, so the nominal anchor of the economy - the exchange rate itself - was very obvious. In that environment, the actions of monetary policy were relatively simple, and in principle there was not much to communicate. But the scenario changed dramatically when we moved to a flexible exchange rate regime and ultimately when a monetary arrangement of inflation targets was adapted. In this scheme, communication is essential to ensure the effectiveness of monetary policy, since everything depends on the effective anchoring of inflation expectations through the credibility generated by the central bank through its actions and the results obtained. Needless to say, communication is also key to accountability, the cornerstone of autonomy.
The autonomy of the Bank of Mexico has worked well, mainly due to the diligent exercise of it. The benefits for society have been patent and very significant. I think I am not exaggerating in saying that the granting of autonomy to our Central Institute has been one of the most successful structural reforms that has been carried out in the country during the last decades. That is why I celebrate its twenty-five years of validity and vote for what.
Source: The Bank of International Settlements, Authorized Journalist (BIS)