Policy Dominance in Argentina

There are at least two meanings for “dominance” in relation to monetary and fiscal policy.

The first one, proposed by Milton Friedman in 1968, is that when monetary policy and fiscal policy are in contradiction, that is, one is expansionary and the other contractionary, the effects of monetary policy tend to prevail.

The other meaning, well formulated by Thomas Sargent and Neill Wallace with their 1981 “Unpleasant Monetarist Arithmetic,” is that, as much as the monetary authorities protest their independence, when push comes to shove, political pressure forces them to support fiscal policy by monetizing debt.

Let us see whether, by using the concept of dominance and its two meanings, we can make sense of the Argentine economy after two years under President Javier Milei’s administration, or whether we need to add another theoretical tool.

What I want to propose in this short essay is that there may be a way to make sense of what is going on in Argentina that is neither purist nor pragmatic, but practical. That is, one that recognizes reality but does not abandon principles. To help us with that, let us talk about policy dominance.

That Milei’s administration generated a primary surplus in the national budget in 2025, I think, is indisputable. We may argue how sustainable and how small it is, we may even consider that perhaps the accounting treatment of accrued but not yet paid interest on short-term notes issued by the Argentine treasury (LECAPs) should be different, and therefore, even if there is a primary surplus of about 1.4% of the GDP, the overall budget has not a surplus of 0,2% of the GDP, but it has a deficit of 1.3% of the GDP.

Still, inflation has been around 30% per year for half a year now.

If you accept Milton Friedman’s concept of dominance, you must conclude that monetary policy has been expansionary despite the reasonable protestations of his administration that there is no more inflationary financing of the federal government.

On the other hand, perhaps, what explains the current high level of inflation, in comparison with the 2025 annual average of 7.2% of the region, is the unpleasant monetarist arithmetic of Sargent and Wallace, and the Argentine Central Bank has been forced, after all, to help the Argentine government to float its debt by monetizing part of it.

To make a long story short,[1] the monetary base grew by 43% and M2 by 27% over the last year. More than 60% of the central bank’s assets are loans and bonds to the central government (not to put a fine point on it—that is plain and simple debt monetization). In addition, more than 46% of the central bank’s liabilities are non-monetary; that is, in addition to everything the central government is printing, the central bank is also borrowing.

The bottom line is that the Argentine government is increasing the supply of money in the economy (both the monetary base and credit instruments) and using those resources primarily to buy foreign reserves.

The argument behind Friedman’s concept of dominance applied to this situation is that an increase in the money supply aims to match an increase in the demand for money in the economy. The persistent inflation above 30% per year has already falsified this claim. It should be obvious by now that there is no such demand in the economy, and, with that, neither plain monetarist explanations nor rational expectations can account for what the government is doing in Argentina.

An alternative explanation, still under the two frameworks we are considering so far, is that the government knows perfectly well that their fiscal policy is insufficient to anchor monetary expectations, and that after an annualized inflation above 200 percent, the people can see 30% as a relief. Meanwhile, the government is gaining time to pass in congress some structural and microeconomic reforms that may effectively reduce the cost of doing business in Argentina and make the economy grow again.

This is why I propose a third theoretical framework to understand what is going on in Argentina, one that would label the Milei administration as practical, not pragmatic.

That framework, in its formal conception, is called “The Fiscal Theory of the Price Level” and has been advocated primarily by John Cochrane, most recently in a booklet titled “Inflation.”

I must confess that I prefer a less formal presentation of the argument, and I found that in Jacques Rueff’s theory of rights as first proposed in his 1945 “The Social Order.”

Risking an oversimplification, Rueff’s thesis is that in the budgetary process, a government may issue claims on real wealth that its taxing capacity is insufficient to pay. If that were the entire story, economic agents would calibrate their expectations to the real purchasing power of the government’s claims and accept them only at a discount. The government, however, has yet another trick up its sleeve: it can force the central bank to accept those claims  at a discount—at face value rather than at market price. Therefore, some of the government’s claims will be traded at face value, and others at a discount, depending on the access particular economic agents have to the central bank’s discount window.

Incidentally, Alex Chafuen and I have already applied Rueff’s ideas to make sense of Milei’s policies, which you can read here. The present essay is one more application of that framework to new data.

As the government’s claims approach maturity, what happens on an ongoing basis is that economic agents’ expectations of being paid in the anticipated purchasing power, or just in nominal terms, materialize.

Mr. Milei inaugurated his government with the promise not to default on the national debt. Formally, he is honoring that promise. However, the amount of debt inherited from previous administrations and the limitations on how much the national budget can be cut mean that, in practical terms, some debt monetization remains necessary, even if a primary surplus has been achieved. A significant number of economic agents in Argentina can see through that and discount the value of the government’s obligations. That takes the form of a low demand for pesos and for pesos-denominated debt, and explains the persistence of current inflation.

While that happens, if the most recent economic activity numbers are right, the economy is growing, an indication that confidence in the reforms is increasing, and there is a chance that Argentina may grow out of its debt.

That is the best interpretation I can give. As someone who wishes the best for Argentina, I hope it is true.

 

[1] For readers eager for data, please check the excellent “currency monitor” tab in the Reform Watch, produced by Universidad Francisco Marroquín in Guatemala.

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