Mexico Opts for “So‐​So” Monetary Independence

January 30, 1998 • Commentary

The designation of Guillermo Ortiz as the new governor of the Bank of Mexico has generated a storm of controversy for two reasons. First, Ortiz was performing the critical job as minister of finance of consolidating the economy’s successful rebound from the financial collapse that followed the peso devaluation in 1994. Second, in light of concerns about the de facto independence of the central bank, a necessary condition of an independent monetary policy, President Ernesto Zedillo’s choice seems dubious at best.

Ruth Richardson, former finance minister of New Zealand, encapsulates the dilemma as follows: If a government wishes to talk the trendy talk of “central bank independence,” then it also better be prepared to walk the walk. An independent central bank should do whatever is necessary to ensure price stability, whether any other branch of government likes it or not. The central bank’s job is not to stimulate growth, promote exports, tinker with exchange rates or create jobs; it is to guarantee price stability. However, putting your finance minister, a member of the ruling party, in charge of that objective clearly does not “walk the walk” of independence. Zedillo’s aloofness from those concerns does not help. In fact, when local journalists queried Zedillo on his choice, asking, “Why Ortiz?” the president shot back with a flippant “Why not?”

Mexico’s history of rampant currency instability underscores the need to enhance the quality of monetary policy, compatible with the central bank’s constitutional mandate to maintain price stability (officially targeted in the long‐​term annual goal of 0–3 percent inflation). Francisco Gil Díaz, the former vice governor, would have been an excellent candidate, but the Zedillo administration deemed him “too independent,” too committed to doing the job his own way. Zedillo’s choice, therefore, generates high opportunity costs: a vacancy left at Finance, the loss of Gil Díaz as a strong and credible governor, and having to wait and see if Ortiz will protect the purchasing power of the currency. Is Ortiz willing to respect that mandate, regardless of whether doing so conflicts with the political interest of his close friend and former boss?

If a government wishes to talk the trendy talk of “central bank independence,” then it also better be prepared to walk the walk.

Some observers think not and have labeled Ortiz’s appointment a new “December mistake,” alluding to the policy mistakes and the peso devaluation three years ago. Although that view is overly harsh, it would be foolhardy to pretend that monetary autonomy is not threatened by naming a seemingly nonautonomous governor. Hard questions have to be asked:

1. Will Ortiz maintain the central bank’s long‐​term target of 0 to 3 percent inflation? Or will he show a willingness to relax monetary policy at the tough ends of the business cycle, in an attempt to maintain growth?

2. Will Ortiz seek full price stability, consistent with his new responsibilities? Or will he give way to the “soft” projections he himself formulated in the medium‐​run plan announced this year, which forecasts double‐​digit inflation until 2000?

3. Will Ortiz condemn all fiscal deficits, regardless of size, as a threat to price stability? Or will he assume a pragmatic stance, as he did in the recently concluded negotiations over the 1998 budget, defending the 200 percent increase in the fiscal deficit for 1998 (from 0.5 percent of gross domestic product to 1.5 percent of GDP) as “reasonable”?

4. Will Ortiz heed the noisy demands of exporters, who continue to press for a system of controlled devaluations? Or will he remember that the only objective of the central bank is to protect the purchasing power of the currency?

5. Will Ortiz keep promises of “avoiding peso overvaluation,” or will he stick to his new promise to maintain a freely floating exchange rate? Zedillo himself contradicted his former minister, when he stated recently that “if a country opts for a freely floating exchange rate, judgments on whether the peso is undervalued or overvalued are irrelevant, since the rate is determined by the market.” Which will it be?

Mexico has a poor track record in price stability over the past two decades, which explains the need for an independent monetary authority, capable of “just saying no” when necessary. For now, Ortiz deserves support in his new duties. He possesses the necessary expertise and credentials. However, a society devastated by the ravages of lengthy periods of inflation and devaluation deserves detailed answers to real questions, certainly far more detailed than “Why not?” After all, for millions of citizens, a sound and stable peso has long been an elusive hope.

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