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Bello
The return of an old enemy
An inflation test for Latin America’s central banks
Mar 12th 2016 | From the print edition
OLDER Latin Americans still have vivid memories of hyperinflation. Bello recalls
changing money in dark doorways in the mid-1980s in Bolivia and being handed a
truncheon of greasy banknotes secured by rubber bands. Peru went through a futile
currency reform in which the sol lost three zeros and was briefly renamed the inti, which
promptly racked up more zeroes.
Hyperinflation destroys businesses, undermines political systems and hits the poor
especially hard. Latin America should have learned this painful lesson. So when in
Caracas recently Bello was given a large shoebox packed tightly with banknotes in return
for a few hundred dollars, he received it with an eerie sense of déjà vu and dismay.
Official statistics put the rise in the consumer-price index in Venezuela last year at 181%,
the world’s highest; the IMF forecasts 720% this year. Venezuela is extreme in its
economic mismanagement. But while the rest of the world worries about deflation, across
Latin America prices are rising. In Argentina, inflation is forecast to spike from 27% to
33% at an annual rate; in Brazil it stands at around 10.5%; in Uruguay, it is only one point
lower, and in Colombia it has climbed to 7.6%. In Chile, Peru and Mexico it has also
ticked up.
The reasons vary somewhat. In Venezuela and Argentina, inflation is mainly the result of
printing money to finance indiscriminate subsidies. Ironically, it is rising now in
Argentina partly because the new government of Mauricio Macri is cutting those
subsidies.
In Brazil, too, the government cut subsidies on electricity and petrol in 2015. But the
main reason inflation is so high there, even though the economy is in deep recession, is
price indexation, according to Edmar Bacha, an economist who helped tame chronic
inflation in the 1990s. By law, the minimum wage was raised in January by 11.6%; it in
turn has a big influence on other wages and the prices of services, as well as on pensions.
And that, plus past fiscal laxity, has made a mockery of the Central Bank’s (unambitious)
inflation target of 2.5-6.5%.
Elsewhere the rise in inflation is the result of currency depreciation, which is driving up
the price of imports (see chart). This is also a factor in Brazil and Argentina. Though very
large, these depreciations are healthy: they are the way that Latin America’s economies
are adjusting to sharply lower prices for their commodity exports. But they pose a
dilemma for central banks that are committed to inflation targeting. In Brazil, Chile,
Colombia and Peru central bankers began raising interest rates last year even as their
economies slowed or were stagnant. Argentina, too, put up its interest rate last month.
The good news is that the rate at which currency depreciation in Latin America is passed
through into domestic price increases is much lower than in the past, according to
Alejandro Werner of the IMF. The Fund’s research shows that before 1999, when several
Latin American countries floated their previously fixed currencies and adopted inflation
targeting, large depreciations were associated with very high rates of inflation. Now the
average pass-through in these countries is below 10% (ie, if the currency depreciates by
10%, domestic prices will rise by less than 1%).
Mexico’s central bank also raised its interest rate last month even though inflation is
below its target. The peso has been clobbered by the fall in the oil price and by the
weakness of manufacturing in the United States, to which Mexico’s economy is closely
linked. Because the peso is very liquid and trades round the clock offshore, betting
against it seems to be “the path of least resistance” for currency traders, says Luis
Arcentales of Morgan Stanley, a bank.
Mexico’s central bank also announced that it would start intervening at its discretion in
the currency market. So is it now targeting the exchange rate, rather than inflation? Not
really: it was worried that the speed of peso depreciation would feed expectations of
higher inflation down the road. “By acting forcefully today it will probably need to tighten
less later on,” says Mr Arcentales.
The currency depreciations of the past two years are the first big test for inflation
targeting in Latin America. One can argue whether individual central banks should have
tightened monetary policy earlier or later. The big picture is that those countries that
have been serious about inflation targeting are adapting to a tougher external
environment at much less cost than those that have not been. They, at least, have learned
the lessons of the 1980s.
From the print edition: The Americas