Uruguay raises reserve requirement to fight inflation

Uruguay central bank ups reserve requirements to combat inflation | Reuters.

This report broke on my Google News Uruguay filter, just as I was making some notes for an upcoming Cost of Living post. That’s probably a few days away, but yes, we are having some inflation problems. This move by the central bank, BCU, to raise the fractional reserve requirements is a big one, and it does make a lot of sense. I don’t know if it will help the inflation problem, but it does help keep our banking and monetary system a lot less likely to crash than, for example, the USA.

Photo of several denominations of Uruguayan currency
Not worth quite as much as when we arrived, but isn’t it pretty?
Photo credit mercopress.com

Relatively short explanation of the “reserve” requirement concept. For a filmed version, re-watch “It’s a Wonderful Life” for Jimmy Stewart’s explanation of why the money on deposit isn’t in the bank. Except nowadays it’s more like Mr. Potter’s bank, not the good old Building and Loan!

Simply put, when you deposit money into the bank, it creates new money. Really, it does. How much new money it creates depends on the reserve requirement.

In the USA, banks are required to keep only a 10% reserve. The rest they can loan out. (Or nowadays, speculate.) So you deposit $100, the bank only has to hold on to $10. They loan out the other $90. But the loan proceeds themselves are deposited in the bank (or in some bank). With the same only-10% reserve requirement. Keep track: Now you have $100 on deposit (only $10 really there), and Jane Doe has a $90 loan proceeds in here account too. Which came from your money. So now there is $190 of money on deposit just from your $100.

Of course, that $90 of Jane’s only has to have $9 in the bank, so now there is another $81 to loan. Which means with only 2 degrees of separation, your $100 has created $171 of new money and in total there is now $271 of money supply instead of just your $100. That is near double again what you started with. And that’s assuming that last $81 is withdrawn as cash so it isn’t creating more money by being in the bank.

There’s a big increase in the money supply, which means more money chasing the same amount of available goods and services, which drives up prices, which is inflation.

Uruguay, on the other hand, had a reserve requirement of 20%, not 10%, for Uruguayan peso deposits. And a reserve requirement double that, 40%, for US Dollar deposits, common here due both to our partially-dollarized (41 page academic PDF) economy, and as an inflation hedge by many everyday uruguayos. Do the math, the money supply expands much more slowly than in the USA. And banks are far less likely to get wiped out by big unexpected demands for withdrawals. In theory.

What Uruguay’s Central Bank just did is slow that money supply growth even further, by raising the UYU (peso) reserve requirement from 20% up to 25%, and the USD (US Dollar) reserve requirement from 40% up to a very high 45%. Hopefully that slows down the high but still manageable inflation.

In the near future I’ll have that post with some concrete, everyday life examples of prices that have gone up, some of our mitigation strategies (hint, it involves what the USA Republicans have been pushing as “chained CPI” along with smarter shopping), and will hopefully put it into our perspective as budget expats. We’re not in the expat real estate game, nor the serial expat game where we’re about to say “oh the heck with Uruguay, let’s go to Paraguay”. We’ll explain what people are doing. Trust me, it’s nothing like next door in Argentina, and frankly it’s not as bad as the Jimmy Carter and early Ronald Reagan era in the USA either, whose “stagflation” hit me hard right when I was starting a family and buying my first home.

Meanwhile, the tube of locally-manufactured local-brand Industria Uruguaya “Pico Jenner Ice” toothpaste I bought today cost 31 pesos. The last time I bought that brand, about 2 months ago, it was 29 pesos. (I found some now-Peruvian Ipana at my local corner “autoservice” self-service family grocery in between, it’s not like I wasn’t brushing my teeth!) Bus fare to Montevideo is now 51 pesos instead of 48. We’ll survive. My health insurance is still under U$S 90 dollars a month. More info soon!

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Mark Mercer

Site co-owner Mark Mercer. AKA Marcos Cristoforo Mercer, AKA the Fuzzy Wanderer. Expat from USA living in Uruguay as of mid-2012, after "test-driving" it for a few months in 2011 and early 2012. Married to Lisamaria, AKA well-known travel and fitness writer Lisa Marie Mercer. Follow Mark on Twitter @mcmxs and his many other sites, which you can find at http://about.me/MarkMercer. I write and engage about many of my other interests, on Google+ at https://google.com/+MarkMercer

2 thoughts on “Uruguay raises reserve requirement to fight inflation”

  1. LOL the first time I skied South America with my ski club from Maine, I totally couldn't send an email!

  2. You say ‘high but manageable inflation’. So what is the official % and (since all governments lie) what does it seem to be actually? Thanks!

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