Mexico's new Minister of Economics is Luis Ernesto Derbez. He will head the economic development project of the administration of Vicente Fox. In a recent interview in the country's prominent business magazine Expansión, Derbez confidently states that the program designed for the Fox administración "is so solid that one can test it under any angle." Derbez's professed key is to reduce real rates of interest to 4 percent -- a level which would generate the sustained abundance of credit required to finance annual growth rates of 7 percent or more.
The macroeconomics of reaching this magical level are simple. Inflation must come down from its current rates of 8.5 percent to internationally acceptable leves of 2 percent to 3 percent, and the government must streamline public expeditures to guarantee fiscal balance, together with a long-term plan of public debt-reduction. The "crowding in" effect of this scenario, under a climate of price stability, would doubtless deliver the goods.
But reaching such a happy macroeconomic environment is no mean task. The key obstacle, as always, is exchange-rate risk -- the perceived risk that an adjustment in the rate of exchange will undo any good economic policy deeds in one fell swoop. This is a history that citizens know all too well, and are desperate to avoid. But this factor seems not to worry the author of "so solid" a plan. Indeed, Derbez firmly rejects monetary reforms that would ipso facto eliminate currency risk -- namely, rapid disinlfation, or radical options that would secure price stability, such as dollarization or currency competition.
The familiar reasons appeal to outdated Phillips Curve trade-offs between stability and growth: a "very restrictive" monetary policy, or dollarization alternatives, entail a high "social cost." The first involves using high interest rates to balance liquidity with low rates of inflation, which would hurt employment. The dollarization option, or some version of super-fixed exchange-rates, Derbez claims, "I dislike." This is because radical reform rules out the use of "yet another instrument [the exchange rate]" as a "cushion against any impact from the exterior."
The popular appeal to exchange-rate "flexibility" reflects a "designer" fashion in the management of exchange-rate policy: the discretionary use of the parity as shock absorber against negative external circumstances, such as a fall in oil prices, or a "hard landing" in financial markets worldwide. In truth, however, such monetary tinkering is equivalent to the worst fears of everyday peso earners: the orchestration of falling real wages as an instrument of policy -- precisely what the frustrated people of Mexico voted against on July 2nd of this year.
The legal analogue for the flexibility claim against broad-based measures to secure a stable monetary climate would have an attorney general stating the "dislike" of invididual rights, because these rule out the "flexibility" to use espionage, torture or other instruments that prevent government from detaining presumed guily parties. This, of course, is absurd. But this is precisely the heart of the debate that Derbez "dislikes." Options for a stable monetary system should not be a function of what is best for enlightened bureaucrats, but rather what is best for the people who invest, save, produce and consume. Should the new head of economic development have the discretionary power to depreciate the currency in name of definding employment, salaries, interest rates or whatever? This is a sophisticated form of exchange-rate slavery.
Besides, as Mexico's monetary history in the past 30 years reveals, a currency depreciation generates higher inflation and higher interest rates, with the outcome of lower growth and job opportunities. This occured with the '94 collapse, whereas Mexican leaders originally justified the exchange-rate adjustment on the grounds that it would help lower interest rates and stimulate growth. The exact opposite occured, amid a brutal contraction of economic activity, near hyper-inflation and exploding bad debts. Since then, the risk of future depreciations is just what maintains real interest rates in the high single digit range.
The abuse of "designer" exchange-rate policy as a cushion aganist external shocks is incompatible with an environment of low interest rates and high growth. The contraction of real wages under a currency depreciation merely masks the need for greater reform in other areas of the economy, such as wholesale liberalization of the energy and electricity sectors, or labor law deregulation. It becomes, as it did under the Zedillo administration, a convenient excuse to postpone more structural reforms and avoid proper risk-management in coping with external shocks.
Besides, a serious discussion on Mexico's monetary challenges should not be ruled out simply because chief economic advisors "dislike" the topic. Cost-benefit analysis shows that Mexico would be better off without the political adminstration of the exchange-rate. In an economy vulnerable to external variations, who should adjust expenses and income, the people or the government? Designer exchange rate policy suggest the former, dollarization or currency competition suggest the latter.
To be sure, there are no free lunches, all forms of adjustment embody cost. But Mexico's new economic authorities should remember that the voting population expressed their preference precisely because, in the past 30 years, the pain of adjustment has been borne by a devalued generation. Giving citizens the choice to transact, invest or save in U.S. dollars may occasion "dislike" among designer bureaucracts, but it remains a decent option to millions of Mexicans who voted for what once seemed a utopian dream: honest public policy.