Latin America rarely leads the world in economic policy. The region has struggled to grow since the last rise in commodity prices, lacks competitiveness and remains overly dependent on commodity exports. But can it teach the G7 anything about fighting inflation?
While central banks in the UK, US and Europe are lagging behind in fighting stubbornly high inflation, Latin America’s central banks have flexed their inflation-restraining muscles and are reaping the rewards.
Good timing helped. Latin America was quick to raise interest rates, starting with Brazil in March 2021 – a full year ahead of the US Federal Reserve.
“Latin America led the tightening cycle,” said Alberto Ramos, chief economist for Latin America at Goldman Sachs. “The central banks didn’t have the luxury of credibility.”
Barely a month after Congress approved the central bank’s independence from government, the Banco Central do Brasil began aggressively raising rates from 2 percent to a lofty 13.75 percent, one of the world’s highest levels for a big economy.
His tactics worked. Brazil is now making gains in its war on inflation, which has fallen from a peak of 12.1 percent in April to just under 8 percent last month.
That success in the price battle hasn’t killed growth: JPMorgan expects the Brazilian economy to grow a better-than-expected 2.6 percent this year, not much less than the 3 percent it forecasts for China.
Chile and Colombia were not far behind Brazil. The two orthodox Andean economies have raised interest rates by 10.75 and 8.25 percentage points respectively and are now almost done with rate hikes. Citi economists expect their rates to peak towards the end of the year, leading to inflation halving next year.
Peru and Mexico complete the picture of Latin American monetary prudence, with increases of 6.5 and 5 percentage points respectively. By contrast, the Fed tightened just 3 percentage points and the Bank of England 2.15 points, despite the US and UK suffering inflation rates similar to some Latin American countries.
The lesson Latin America offers the world, says Ilan Goldfajn, director of the Western Hemisphere at the IMF, “is that if you are ahead of the curve, if you react quickly and get where you need to go, that helps to battle to win. against inflation”.
The Latin American exception, as so often, is Argentina. The government-controlled central bank is printing money to fund a budget deficit and is losing control over inflation, which is expected to end the year at 100 percent.
Latin America’s central banks have eased monetary policy more than the G10 during the pandemic. But their later assertiveness was not just a response to higher inflation. “Every country in LatAm has tightened the real ex-ante policy rate [the policy rate adjusted for one-year ahead inflation expectations] to positive territory, while every central bank in the G10 is still below zero,” Bank of America said in a recent survey.
High real interest rates have also kept Latin America’s currencies strong. As the pound, euro and yen weaken against the strong dollar, three Latin American currencies have appreciated against the US currency this year: the Brazilian real, the Mexican peso and the Peruvian sol.
So why did Latin America’s central banks act so decisively while their developed world counterparts hesitated?
Alejandro Werner, director of the Georgetown Americas Institute and Goldfajn’s predecessor in the Western Hemisphere Department of the IMF, believes the G7 central banks place too much faith in flawed economic models.
“In the advanced economies, we are much more model-based,” he says. “And if you put 25 years of data into your model where inflation has been around 2 percent, whatever you put on the independent variable side won’t give you an inflation rate much higher than 2.5 percent. . . the data you feed the model gives you an answer that leads to complacency.”
By contrast, he said, Latin American central bankers use models “but they also use their experience and their experience with inflation is much more recent”.
Goldman’s Ramos also believes that Latin America’s painful experience of high inflation has made it clear to central bankers how dangerous the inflation threat was.
“Central banks in the developed world had never seen anything like it, but in Latin America, central bankers understood that when inflation exceeds 5 percent, there is regime change,” he says. “At 5 or 6 percent inflation feeds itself and becomes a monster. She [developed world central banks] never understood that.”