Latin America’s Inflation Challenge

IMF Blog, November 16, 2021

Source details

Average inflation in Brazil, Chile, Colombia, Mexico, and Peru (the LA5) was below the average for other emerging market economies in the first year of the pandemic and is now higher.
Average inflation in the LA5 was 8 percent year-on-year in October.
In the case of Brazil, inflation has surpassed 10.5 percent.

Soaring food prices:
- Food prices started increasing even before the pandemic.
- Food prices have risen more than 18 percent on average in LA5 countries since January 2020.
- In Latin America, food prices make up about a quarter of the average consumption basket.
Even core inflation (which excludes food and energy prices) has exceeded the pre-pandemic trend, reaching an average of 5.9 percent year-on-year in October.
Other contributing factors include commodity price shocks, supply bottlenecks, and rising shipping costs.

Higher food bills reduce disposable spending on other goods for households affected by the coronavirus crisis.
In a region with the highest levels of income inequality, the burden of higher food prices is greatest for low-income households who spend a larger share of their income on food.

Inflationary pressures are expected to be temporary and medium-term inflation will likely revert to central bank targets, but there is considerable uncertainty.
The pandemic shock is unique; its effects on commodity prices, supply bottlenecks, and shipping costs are hard to pin down.
Historical context:
- A long history of high and unstable inflation in the region poses challenges for central banks that have only recently established credibility.
- Indexation practices (contracts that adjust their terms automatically with inflation) may accelerate prices further.
Financial risks:
- Rapid and unexpected tightening of international financial conditions in response to inflation in advanced economies could lead to capital outflows.
- Capital outflows could jeopardize financial stability and depreciate currencies in Latin America, adding to inflationary pressures.

Managing expectations—through public statements or rate hikes—is key to preventing an inflationary spiral.
Central banks in the region are moving quickly to preserve credibility:
- All LA5 countries have already hiked policy rates.
- Monetary authorities have shifted up forward guidance.
Despite recent rate hikes, monetary policy stances generally remain accommodative and continue to support the ongoing recovery.
Policy trade-offs:
- Authorities must balance an uncertain inflation outlook with employment still substantially below pre-pandemic levels and an uneven recovery in the region’s jobs market.

Source: IMF Blog post “Latin America’s Inflation Challenge” by Maximiliano Appendino, November 16, 2021.