As for Argentina, chronic inflation and currency depreciation have cemented a clear preference for the US dollar as a store of value. The compulsory pesoization in January 2002 (when existing US dollar deposits and loans in the domestic banking sector were forcibly converted to pesos) provided only a temporary and artificial reduction in the domestic use of the US dollar. Saving rates are low, and a nontrivial share of private savings is held outside the country. As Christoph Trebesch and I have highlighted, reliance on fickle foreign saving does not help with currency instability or external indebtedness.
So, what can governments do to induce turning points in stubborn inflation expectations when central banks’ policies prove insufficient to the task?
In the case of Japan, convincing the private sector that higher inflation is the path of the future requires a break from the current practice of indexing public-sector wages to the previous year’s inflation. Bold increases in public-sector wages may provide the official signal that has been lacking, with private-sector wage and price setting following suit. The very fact that such a measure would run counter to fiscal prudence in such a highly indebted country might help undermine the entrenched trend toward yen appreciation. Higher inflation has to be part of the solution to the existing overhang of public and private debt.
As for Argentina, to avoid fueling a classic wage-price spiral, de-indexation requires significant reductions in real wages, starting with the public sector. The political difficulty of doing this (especially when the public sector is large, as it is in Argentina) is daunting at the best of times; in an election year, there is (at least as far I am aware) limited historical precedent for it. Apart from dampening inflation expectations, real wage cuts mitigate the real exchange-rate appreciation (loss of competitiveness) that often accompanies disinflation plans. For a country like Argentina, facing increasing difficulties in global capital markets, current-account deficits are a luxury.
Perhaps inflation expectations are stubbornly high (or low) because the public has learned to extrapolate from another historical trend: governments tend to avoid making difficult choices.
Carmen Reinhart is professor of the international financial system at Harvard University's Kennedy School of Government.