Monetary Policy in Latin America Does it help to mitigate the crisis or creates new problems?

Monetary policy in Latin America Does it help to mitigate the crisis or creates new problems? Buenos Aires, Argentina March 2, 2009 until the outbreak of the crisis, monetary policy occupied a central role in controlling the dynamics of both inflation and economic growth. Monetary policy of inflation targeting had expanded successfully and increasingly adopted countries. In Latin America, most central banks are implementing a monetary policy of inflation targeting, where the Central Bank of Chile has been a forerunner. They also apply this type of monetary policy Brazil, Mexico, Peru and Colombia, among the major economies of the region. Argentina, which is another of the major economies of the region, apply a monetary policy based on monetary aggregates as an intermediate target, justified by the weakness of the transmission channels of monetary policy does not allow another type of strategy.'s Monetary policy inflation targeting, which is, roughly, to announce an inflation target level which seek to be hit by the monetary authority has been very useful in Latin America to restore the credibility of central bankers. The history of the region with high levels of inflation than a few bouts of hyperinflation has created the need to rebuild credibility. However, the crisis has generated an unexpected phenomenon for central bankers not only in developed countries but also in Latin America: the incidence monetary policy to control inflation dynamics and reduce the impact of the crisis has been minimal.

This phenomenon has been observed both in developed economies and in those developing countries in general and Latin American economies in particular. The explanation for the low incidence of monetary policy in controlling inflation and economic stimulus is in the magnitude of the external shocks affecting the economy. Thus, central bankers could do little to curb rising inflation face of rising international prices of energy and agricultural commodities so that amid the crisis, the economies experienced inflation levels not seen for several years . Towards the end of 2008, with the global economy falling into a deep downturn, inflationary pressures gave strongly and without that central bankers do much about it, the inflation rate began to drop sharply to readjust at levels below the precrisis in many cases. The current scenario shows several developed economies at risk of deflation.

During most of 2008 the impact of external factors on Latin American economies caused the inflation rate rising to behave despite the tight monetary policy carried out by the economies of the region that inflation-targeting. But just as external inflationary pressures pushed up the inflation rate, the impact of external factors from the fourth quarter of 2008 significantly influenced the slowdown in inflation dynamics which allowed the American central bankers start cycle of interest rate cuts to shore up economies hit by the global financial crisis. This lax monetary policy is failing so far the expected results given the weakness observed in the transmission channels of monetary policy. However, this is not the only concern related to the dynamics of monetary policy in Latin America. The cycle of rate cuts is reducing the existing rate differential with major world economies, which is affecting the exchange rate, increasing the risk of inflation. Thus if, in its latest monetary policy meeting, the Central Bank of Chile made a cut of 250 basis points in interest rate, which stood at 4.75%, and not ruled out further cuts.

The Central Bank of Brazil for its part, cut the Selic rate by 100 basis points at its last meeting. In the case of Banxico, the benchmark interest rate was cut by a quarter point, reaching 7.5% although the cuts will continue given the weakness observed in the Mexican economy. The Reserve Bank of Peru, surprisingly reduced its interest rate to 6.25% in February (25 points), while Colombia's central bank slashed on Friday its benchmark interest rate by 100 basis points bringing it to 8 %. If we observe the evolution of the exchange rate in Latin American countries, we find that since September 2008 in all cases, have suffered a depreciation against the U.S. currency, although some of them, the depreciation has been very pronounced. Such is the case of Mexico, Brazil and Colombia. In the case of Mexico, the dollar went from trading at $ 10.28 at the beginning of September to $ 15.09 in late February 2009. In Brazil, the dollar went from trading at R $ 1.632 to $ 2.313 A, while in Colombia, the exchange rate went from $ 1934.24 to 2544.53 in the same period. The weakening observed in exchange rates has not useful to generate an improvement in the economy via the external sector and high inflation risk involves the transfer of the weakening of local currency into domestic prices.

It also reinforces the disincentive for foreign investment may deepen the output of these countries in the region, further undermining exchange rates. What must Latin American central bankers before the inefficiency observed in their monetary policy and higher risks of instability they generate? The inefficiency observed in the last time in monetary policy necessitates the existence of a rethink of monetary policy actions are being implemented. Probably the continued cuts in benchmark interest rates in the countries of the region is not the solution to prevent the continued slowdown in growth. Perhaps more appropriate for central bankers working on other mechanisms to facilitate the generation of credit to shore up the economies in this way to a domestic demand appears weak. Is there a risk of burst of inflation in the economies of the region's product weakening exchange? The weak global economy and the economies of the region makes it unlikely that there is a strong effect transfer to domestic prices of currency weakening. However, excessively weak exchange rates imply a higher level of future inflation (especially in the global economy begins to recover), which will force central banks to tighter monetary policy. While the inflation risk exists in the medium term, in the short term, some economies may face the risk of deflation.

In recent months, there has been monthly deflation in the economies of Chile, Brazil and Peru. In Mexico, the Ministry of Economy expects the economy falls into deflation. So the short-term deflationary risk makes it convenient to continue with cuts in benchmark interest rate? Not necessarily. The problem lies in the weakening of both external and domestic demand in the economies of the region. Monetary policy has been effective in recovering any of them. Therefore, there is no assurance that further cuts in benchmark interest rates to avoid the risk of deflation. Latin American central bankers again entering a complex scenario in which policy actions are not achieving the desired impact and threaten to produce unwanted effects. Is it time for a deep stake in them?