Rising prices for food, fuel and other household necessities are rattling people throughout Latin America and the Caribbean and hitting poor families already affected by the pandemic especially hard. But if inflation is again haunting the region, and policymakers are worried, it is important to keep the new developments in context.
Inflation is far from a regional phenomenon. Many countries around the world, including those in the group of most advanced economies, are dealing with inflationary pressures (Figure 1A). Global factors, including stronger than expected recoveries from the pandemic in 2021, the persistence of supply bottlenecks, and the effects of the large expansionary fiscal and monetary policies, play a significant role. The sharp increase in commodity prices, resulting in part from the war in Ukraine, have also been important, giving inflation an extra jolt in 2022. All these factors indicate that rising inflation in many countries of the region (Figure 1B) is hardly an outlier.
Figure 1A: Inflation Rates in Different Regions
Figure 1B: Inflation Rates Across Monetary Regimes in Latin America and the Caribbean
We do not need to travel far into the past to see inflation rates similar to those we see today in the region. Restricting the analysis to the post-2005 period, we see that most countries in the region experienced inflation rates before the pandemic that were comparable or even higher than the latest inflation numbers. That inflation experience was generally concentrated around the Global Financial Crisis of 2007-08, but there are many exceptions, such as Brazil, Colombia, and Uruguay in 2016, when annual inflation in those countries stood at around 10% (Figure 2). Most of those episodes were temporary, in line with the reality that most official medium- to long-term inflation expectations have not risen much recently.
Figure 2: Inflation Rates for Brazil, Colombia, and Uruguay.
The fiscal and monetary history of Latin America and the Caribbean has taught us that accelerating inflation rates that surpass 20% per year for many months are associated with one main culprit: the persistent monetary financing of fiscal deficits. Where that occurred, monetary authorities set aside their price stability goals and printed money to finance deficits. This characterizes the current situation in a small group of countries in the region, but for most of the other countries, inflation rates are well below those levels, and monetary authorities still have enough autonomy to refrain from repeating those mistakes.
Most central banks in the region adopted substantial expansionary monetary policies during the pandemic, with many cases resembling monetary financing. But those were one-off measures to help governments and citizens during a turbulent time. Most central banks showed enough autonomy and commitment to pursue their price stability mandate, quickly tightening their monetary policies (e.g., increasing their policy rates) when inflation started to rise in 2021.
There is still uncertainty around whether the global factors that triggered inflation in the first place will remain in action and around the pace of monetary tightening that central banks will adopt. However, most countries in LAC have abstained from repeating the policies that created persistently high inflation in the past. For that reason, inflation should fall in the medium to long-term as long as governments respect the autonomy of their central banks and allow them to focus on their price stability mandate.
In the meantime, governments should adopt policies to protect their countries’ most vulnerable members. These, among other things, should favor targeted transfers instead of subsidies and price controls that generate distortions in the economy. If countries lack the fiscal means to do so, fiscal reforms will be necessary.
Indeed, the region’s fiscal situation is likely to be an even more important concern than inflation in the coming years. After all, persistently high inflation is just one symptom of the lack of control over government finances. And with debt levels at a record high and uncertainty surrounding the global economy, countries may experience reduced access to funds, making it more difficult to meet their financing needs.