Background on the Banco de México and Inflation Targeting
The Banco de México, Mexico’s central bank, recently decided to lower the interbank interest rate by 50 basis points, setting it at 8%. This decision comes despite the upward trend in general and underlying inflation rates over recent months, with levels at 4.51% and 4.20%, respectively, during the first half of June.
Inflation Trends and Central Bank’s Projections
During the same meeting, the Banco de México revised its inflation projections upwards for upcoming quarters, while maintaining its increasingly dubious forecast that the 3% target would be achieved by the third quarter of 2026.
Policy Inconsistency and Its Implications
The interest rate reduction, coupled with the upward revision of inflation projections and persistent inflation expectations above 4%, suggests that the monetary policy implemented by the central bank may not be consistent with its constitutional mandate to ensure price stability. It appears that the Banco de México governing board members have either decided to abandon or become complacant with the inflation target, allowing it to hover near the upper limit of the 2-4% band.
The Importance of a Punctual Inflation Target
When the Banco de México adopted inflation as a target, it established a 2-4% range. However, having a punctual target rather than a range is crucial for several reasons:
- Policy Consistency:A punctual target encourages the central bank to implement a monetary policy consistent with the upper limit of the range, reducing the risk of exceeding it. Without a precise target, the likelihood of achieving the desired inflation rate diminishes.
- Long-term Impact:Over a decade, an annual inflation rate of 4% would result in a cumulative inflation of 48%, whereas an annual rate of 3% would lead to 34.4% and 2% to 21.9%. The maximum inflation rate for stable prices and fulfilling the central bank’s mandate is 2%, not 3% or 4%.
Inflation as a Regressive Tax and Economic Distortion
Inflation acts as a form of expropriation, where those with the ability to create money—the central bank and commercial banks—appropriate a portion of individuals’ real wealth held in cash or bank accounts. This mechanism violates the rule of law and disproportionately affects lower-income individuals who have fewer opportunities to mitigate the impact through foreign currency holdings or interest-bearing financial instruments.
- Regressive Nature:Inflation is the most regressive tax, as it negatively impacts everyone but disproportionately harms lower-income individuals with limited capacity to protect their wealth through foreign currencies or interest-bearing assets.
- Economic Distortion:High inflation distorts the economy by corrupting relative price signals, shortening saving and investment horizons, widening real interest rate differentials, and discouraging economic growth—all of which result in reduced social welfare.
Call for Action: Achieve a Maximum Inflation Target of 2%
Given the detrimental effects of inflation, the Banco de México must commit to swiftly achieving a maximum inflation target of 2%. Failing to do so, the consequences should be demanded by the nation.
