Policy Interest Rates in Latin America: Moving to Neutral?
IMF Blog, November 19, 2012
Source details
- Canonical URL
- Policy Interest Rates in Latin America: Moving to Neutral?
Other formats
Bibliographic details
- Authors: Nicolas Magud, Evridiki Tsounta
- Published: November 19, 2012
Real interest rates and the neutral concept
- The neutral interest rate is defined as "the real interest rate consistent with the economy operating at full employment and stable inflation."
- Policy guidance:
- If the economy operates above potential and inflation is rising, policymakers should raise the policy interest rate above the neutral level.
- If the economy operates below full employment, interest rates may need to be lowered below the neutral level.
Estimating neutral rates
- Study scope and methods:
- Neutral interest rates are unobservable; no single best method exists.
- The study estimates neutral interest rates for 10 Latin American countries using several different methodologies to obtain a range of plausible values for each country.
- Sample composition:
- Countries with full-fledged inflation targeting: Brazil, Chile, Colombia, Mexico, Peru, and Uruguay.
- Countries that recently transitioned to inflation targeting: Costa Rica, the Dominican Republic, Guatemala, and Paraguay.
- Key empirical findings:
- Financially developed economies with a longer history of inflation targeting typically have lower neutral interest rates.
- These countries tend to have stronger economic fundamentals (for example, lower inflation uncertainty and sovereign risk premiums measured by JP Morgan’s Emerging Market Bond Index (EMBI) spreads).
- Notable exception: Brazil has the neutral rate among the highest in emerging economies.
- Stronger economic fundamentals and the easing of global financial conditions (reflected in lower federal funds rates) have produced a downward trend in neutral interest rates, with recent exceptions being Brazil and Uruguay.
Comparing actual policy rates to estimated neutral rates
- Countries where current policy rates are close to neutral:
- Chile
- Colombia
- Peru
- Countries where monetary policy remains stimulative (actual interest rates below neutral):
- Brazil
- Mexico
- Countries where actual interest rates are below estimated neutral levels (with caution due to data limitations and weaker transmission):
- Costa Rica
- The Dominican Republic
- Guatemala
- Paraguay
- Uruguay
Policy implications and challenges
- Monetary policy decisions are challenging owing to many unknowns such as:
- The position of the economy in the business cycle.
- Likely future economic shocks.
- A volatile external environment.
- Reliable estimates of country-specific neutral rates can help central bankers in Latin America set the course for monetary policy.
Nicolas Magud, Evridiki Tsounta — November 19, 2012
Content in this bundle
- On Neutral Interest Rates in Latin America
- wp12243
