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Inflation Down, But Not Out

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Latin America's inflationary pessures are down, but not out.

BY CLAUDIO LOSER
Latin America Advisor

How things change in a year. By the end of 2007 in this same space it was indicated that "inflation is coming back worldwide in response to an unfortunate combination of higher energy and food prices, and expansionary monetary policy." Today, as the financial crisis continues to unfold, commodity prices have declined to levels probably not seen in the last four years; monetary policy is expansionary, but with a collapse of credit markets, liquidity is squeezed; the industrialized world is well into a recession; emerging economies if not in recession are slowing down sharply. In these circumstances, the expectations on world inflation have been scaled back a lot for 2009.

NOT GONE

However, the legacy of the high world demand through mid-2008 is far from gone. In the United States, in Europe, and in Japan, inflation will fall in 2009 as the decline in commodity prices and the effect of higher unemployment on wages work their ways through the pricing structure.

This is also the case in Latin America. After reaching a record-breaking low inflation rate in 2006, at 4.7 percent, inflation rose in 2007 by almost 2 percentage points to 6.5 percent. It was estimated to have increased further to 8.5 percent in 2008. During the first part of the year, this reflected the increase in world demand, but in the second half of 2008, as these trends reversed, many of the countries in the region experienced major currency devaluations, including Brazil, Mexico, Chile, Colombia, Uruguay and to a lesser extent, Argentina. In many countries, consumers were shielded from the rapid increases in international prices through a wide array of subsidy schemes.

Thus, the unwinding of these world price tendencies had only limited impact on domestic prices. However, the currency devaluation is having an impact on prices. This will require fine tuning by the monetary authorities, preserving the past hard-won success on inflation, while avoiding too tough a monetary policy stance. Unfortunately, it is far from certain that the monetary authorities will strike the delicate balance that would not offset both the effect of the devaluation on competitiveness, and any attempt to support demand through fiscal stimulus plans.

WIDE DIFFERENCES

In any event, it is most likely that during the year 2009 Latin America will experience a decline in the rate of inflation from the peak observed in 2008. The region's overall price increases may average about 6.5 to 7 percent, but as usual with a wide country dispersion. On the low side, countries like Ecuador, Panama and El Salvador, with the U.S. dollar as their currency, as well as Mexico and Peru, may experience inflation rates below 4 percent. Brazil, Chile, Colombia, and some of the Central American countries can expect to have inflation rates below or about 5 percent, with somewhat higher ones for the Dominican Republic, Uruguay, and Costa Rica.

Inflation can be expected to slow down in Argentina from the previously observed levels of 25 to 30 percent. It will remain one of the two outliers, together with Venezuela, with rates above 20 percent, as demand pressures remain even as their terms of trade weaken dramatically. This can be avoided in an orderly fashion only if governments introduce much more balanced macroeconomic policies, in line with other countries in the region.

Claudio Loser is a Senior Fellow at the Inter-American Dialogue and former head of the Western Hemisphere Department at the International Monetary Fund. Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.

 

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