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Global Perspectives: Banco de México’s Alejandro Díaz de León on COVID-19, Trade and Inflation Targeting

Mark A. Wynne

October 27, 2020

Alejandro Díaz de León was appointed the governor of Banco de México by the president of Mexico in December 2017. He is a career economist and has served in a variety of positions at the central bank. His public service career has also included appointments at the Mexican Finance Ministry and Mexico’s Export-Import Bank. He has been twice named Latin Finance’s Central Bank Governor of the Year.

The Federal Reserve Bank of Dallas recently hosted Díaz de León as part of the Bank’s Global Perspectives speaker series. This series was launched at the beginning of 2016 with the objective of bringing leaders from the worlds of business, academia and policymaking to the Dallas Fed to share their insights on global, national and regional developments.

The Dallas Fed has a longstanding relationship with Banco de México that stretches decades. The inaugural event in the Global Perspectives speaker series featured Governor Díaz de León’s predecessor, Agustín Carstens, currently the general manager and head of the Bank for International Settlements.

Díaz de León and Dallas Fed President Robert S. Kaplan discussed COVID-19, the United States–Mexico–Canada Agreement (USMCA) and inflation targeting. The following are excerpts from their conversation, edited for clarity, and presented by topic.

 

On the Impact of COVID-19:

Díaz de León: It has been very challenging not only because of how easy it is to catch the disease, but especially so in countries like Mexico where the informal sector is large. It is very hard to tell the population to stay at home. People have to get out and make a living.

It’s very hard to have these strict confinement restrictions and for them to be followed. I think this is something that is common in Latin America, as you can see by the dynamic of the pandemic. Even in countries that had a longer period of confinement or even a stricter period of confinement, they have not been able to really have a significant inflection point downward in terms of contagion and deaths.

It has been really unfortunate that this highly contagious disease has materialized, given that we have this large informal sector, and we have large urban cities where the density is quite high, making it very complicated to bring down the contagion. It has had a human toll, which has been very high.

In terms of the economic effect, we have seen that this has been a challenge in terms of disrupting the supply side and production, and also the demand side, as we have households and companies that had a reduction in their sources of income. Obviously, more-advanced economies with more financial resources have been able to put aggressive, front-loaded fiscal packages in place to try to compensate and reduce job losses and to increase disposable income for households.

In emerging markets, we have seen not only a rapid contagion and challenges from the health and human dimension but also a reduction in public-sector revenues coming from a contraction of the economy and even from [falling] commodity prices, which obviously went south when the pandemic materialized. Reduced fiscal space from an already challenging environment has made things harder. Of course, you can always debate what’s right and the room that you have to maneuver, and that has been highly debated in Mexico.

We have been of the view that we need to have sustainability in the fiscal accounts. If you want to spend more, you should find additional sources of revenue—even if they are not for this year or the next—but sustainable sources of revenue to compensate for that additional expenditure. That has not been done in a significant fashion in Mexico and is making the business cycle more acute and more pronounced.

Evolving from the North America Free Trade Agreement to the USMCA:

Let me start by saying that I think NAFTA [North America Free Trade Agreement] has been a very good instrument to better integrate North America. I truly believe that the comparative and relative advantages of the three countries [Mexico, the United States and Canada] really point toward having this type of deep integration.

Obviously, we had a very significant challenge, I would say, all over North America, but especially in Mexico, with China’s accession to the WTO [World Trade Organization]. Clearly, with a very similar export basket to Mexico, it was a significant challenge. Nonetheless, I think the deepening of trade and the insertion of Mexico’s exports in global value chains is really an example of a success story.

Nonetheless, I think it is clear that not everything is [about] trade, and you have to be mindful about different things. I understand that there were some questions about other things regarding the integration, not necessarily only the trade narrative. That’s probably why this revision that ended up in the USMCA came about.

With the USMCA, we first of all have more clarity, less uncertainty. Of course, that also comes with challenges. Some of the challenges are in the auto sector where we have clearly some increases in local content [requirements] that may be challenging. We know that if we have a static response, that means no response. Even those restrictions that may go against the auto industry in the whole of North America entail an opportunity if a dynamic response is engaged in trying to increase integration within the region.

It is very important that we have attained an upgrade in terms of some sectors that were not included before, like e-commerce, more deepening in terms of property rights and [such] things that are very important.

And it shows that it’s not only about trade. It’s about institutional convergence in terms of property rights, in terms of these labor elements, that were included. I would say this was done to level the playing field and to also highlight that we are more similar than different. I think when trade comes about in countries that are very different other than in trade, some [other] things at the end of the day surface that may deteriorate the trade relationship.

Challenge of Inflation Targeting, Overcoming Past Expectations:

When we had inflation expectations north of our target [3 percent], we used to get questioned. That’s because there is not sufficient credibility. Now looking to the advanced economies of the world, you have a 2 percent inflation target, and you have long-term inflation expectation south of that. And the question is, is there insufficient credibility in the central bank? I think that it is not really only a function of credibility. It is also a function about past data.

Any forecaster is going to have a hard time expecting a number that has not been in the data sample for quite some time; they’re going to be mean reverting. What has been the mean, the observed mean? Well, that’s going to have a lot of influence on my forecast. Unless we attain and maintain inflation around the target for a sufficient period of time, expectations are going to be basically where inflation has been, not where we would like it to be.

And that points toward a different type of challenge. In the case of Mexico, we have probably been more prone to shocks that have put upward pressure on prices, and I think in the case of advanced economies, you have been more prone to shocks that have put downward pressures on prices. So, it’s also conditional on the type of shocks that you face.

If everything would be without shocks, we would converge immediately toward our target. But in a world with sufficient shocks, I think that the shocks have a lot to say about where inflation has been and where inflation expectations are more or less anchored, even if that doesn’t make us happy because it’s not in our targets.

Value of Public Service Relative to Private-Sector Work:

I think public service has been very interesting for me to try to understand economic problems and try to change them for the better. If you are in public service, the scope and the impact of that is larger in emerging markets, where institutions in general are less mature. The scope of adding value in that dimension is larger.

At the end of the day, I think we all like to add value. You can add value in the private sector or in the public sector, but probably the scope of how much value you can add and how much you can change is larger in the public sector than in the private sector. The challenge or the key issue is to try to understand the complex environment where we are and try to see how you can change things for the better.

About the Author

Mark A. Wynne

Wynne is vice president and associate director of research in the Research Department at the Federal Reserve Bank of Dallas.

The views expressed are those of the author and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.

Economic ConditionsMonetary PolicyCOVIDMexicoInflation

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