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Rising inflation in Latin America: Central Banks at a crossroads

Understand the recent pressure on prices in the region's largest economies, caused by the COVID-19 pandemic crisis

Inflation in Latin America represents a growing risk and a challenge for the Central Banks of the region, which will have to decide between supporting the region’s economic recovery or resume their anti-inflationary mandate sooner.

As expected, the continuation of expansionary or ultra-expansionary policies in the region, coupled with the global powerhouses’ (China and the U.S.) accelerated recovery, contributes to generating inflationary pressures in Latin America. Price increases are gaining speed in some of the region’s largest economies.

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Within the region’s five countries with independent Central Banks, inflation has been out of range in Brazil (at 6.1%, above the upper limit of 5.25%) and Mexico (4%), while in Peru, it has been above its target threshold of 2% in the first three months of the year, and in Chile, it is around the 3% forecasted for the period, but with an upward trend since the middle of last year. Only in Colombia, inflation remains below its 3% goal but runs the risk of starting to rise in the face of prolonged expansionary monetary policy.

Latin American inflation, as in most emerging markets, has external and internal factors. Among the external reasons is the rise in international food and energy prices, that is, imported inflation. Within the internal causes for inflation are the interruptions in internal production processes caused by the persistence of the pandemic, which limits the supply of goods and services, and the monetary root caused by the prolonged expansion of monetary conditions implemented by the Central Banks. This last cause must be highlighted because it implies a risk for the economic recovery as a whole and a challenge for the failure of Central Banks.

READ ALSO: Inflation in Mexico rises to its highest level since 2017

Monetary policy remains expansionary in the region, both in terms of the price of money and its supply. Interest rates are well below neutral rates (the rate considered adequate to stimulate the economy without generating inflationary instability) in the five countries already mentioned. At the same time, the real amount of money per unit of product is growing at a much higher rate than the historical trend. This means that the actual amount of money in circulation is much greater than the amount of goods and services produced in the economy. Therefore, this excess money is accommodated in higher prices or imports.

READ ALSO: Chile’s Central Bank: as vaccination drive pays dividends, the country’s economy gains steam

Resuming control of inflation, therefore, implies applying the opposite remedy to the one prescribed so far. But how? This is a question that has not yet been answered.

Central banks in Latin America are mainly banks with single-purpose monetary mandates. That is, its constitutional mandate is to preserve price stability. Only the Central Bank of Colombia has economic growth or full employment, in addition to inflation, as an explicit part of its mandate. If they fulfill their mandate, they may even contain inflation, but at the risk of weakening their countries’ economic recovery.