## Sticking to the Target ## Source details **Canonical URL:** [Sticking to the Target](https://www.imf.org/en/publications/fandd/issues/2023/03/pov-colombia-sticking-to-the-target-leonardo-villar) ## Other formats - [Markdown version](/en/publications/fandd/issues/2023/03/pov-colombia-sticking-to-the-target-leonardo-villar/index.md) - [Structured JSON version](/en/publications/fandd/issues/2023/03/pov-colombia-sticking-to-the-target-leonardo-villar/index.json) - [Bundle manifest](/en/publications/fandd/issues/2023/03/pov-colombia-sticking-to-the-target-leonardo-villar/bundle-manifest.json) ## Bibliographic details - Authors: LEONARDO VILLAR - Published: March 1, 2023 --- ### Overview - Inflation-targeting adopted since 1990 generally reduced inflation and inflation volatility in countries that implemented it. - In several emerging market economies, inflation targeting shifted procyclical monetary policies into countercyclical action, contributing to GDP growth stabilization. - Colombia adopted inflation targeting in 1999 after three decades of stable but stubbornly high inflation. ### Historical experience in Colombia - Before 1999: - Central bank faced complex indexation mechanisms perpetuating inflation. - Exchange rate was used as the nominal anchor amid relatively high inflation and a volatile balance of payments, forcing procyclical monetary responses. - After adopting inflation targeting: - Authorities allowed the exchange rate to fluctuate and used the inflation target as the main nominal anchor. - Monetary responses to major shocks: - Global financial crisis in 2007–09: allowed depreciation while relying on inflation target credibility. - COVID-19 shock in 2020: similar approach of exchange rate flexibility and inflation-target anchoring. - 2014–16 inflationary shock: - Causes: drop in terms of trade after oil price collapse, severe drought, other supply shocks. - Annual nominal depreciation reached 68 percent in 2015. - Inflation rose from about 3 percent in mid-2014 to 9 percent in July 2016, then returned to the 3 percent target years later without a major sacrifice in output. - Credibility of monetary policy and stability of long-term inflation expectations were instrumental. ### Post-COVID challenges and recent inflation dynamics - Since 2021, inflation-targeting regimes have faced extreme challenges; credibility in keeping inflation close to target has not held since 2021. - Colombia specifics: - Inflation rose from less than 2 percent in 2020 to 13.1 percent in 2022, the highest level since inflation targeting was adopted. - Food prices rose at a yearly rate of nearly 28 percent in 2022 due to domestic and international supply shocks. - GDP growth: more than 10 percent in 2021 and 8 percent in 2022. - Current account deficit: widening and close to a historical record in 2022. - Core inflation (excluding food and government-regulated prices) went from 2.5 percent in 2021 to 9.5 percent in 2022. - Exchange rate depreciation: by end-2022, the Colombian peso had depreciated 38 percent compared with early 2021. - Minimum wage increases: - 2022: raised by 10 percent. - 2023: raised by 16 percent. - These increases were well above headline inflation and contributed to higher production costs and a wage-price spiral. - Fiscal context: fiscal deficits were much larger than regional peers over the past two years, worsening investors’ country-risk perception. ### Policy response, communication, and credibility - Monetary tightening: - Banco de la República raised the policy interest rate from 1.75 percent in September 2021 to 12.75 percent in January this year. - Communication challenges: - Large, protracted inflationary shocks require a long period of convergence to the inflation target that must be explained to the public. - Tradeoffs: - Too fast a convergence can be very costly in terms of output and employment. - Too long a convergence risks de-anchoring inflation expectations. - Central bank commitment: - Tightening process is stated as "not over." - Committed to bringing inflation down to its 3 percent target over a two-year period with an acceptable deviation of 1 percentage point. - Inflation expectations are broadly consistent with the desired convergence path. ### Outlook and policy implications - Inflation trajectory and credibility: - Inflation is expected to decrease fast by historical standards but will probably be above its target rate for the longest period since the inflation-targeting regime was introduced. - Maintaining the credibility of the target as the main nominal anchor will be more difficult. - Growth outlook: - Expecting a sharp deceleration of economic activity that would shrink GDP growth to a meager 0.2 percent in 2023. - Drivers of slowdown: tighter global financial conditions, slower growth in trading partners, and contractionary domestic monetary policy needed to guarantee inflation convergence. - Policy stance and recommendation: - These challenges are not an argument against inflation targeting; they reinforce the need to strengthen its anchoring role. - The central bank should pursue a contractionary monetary policy at the current juncture to demonstrate commitment to an explicit and credible inflation target. - Inflation targeting coupled with a floating exchange rate has helped Colombia confront shocks in ways not possible before; enhancing credibility remains the preferred path through challenging times. *Sticking to the Target, LEONARDO VILLAR, March 2023 (F&D Magazine).* --- ## Content in this bundle - **F&D March 2023: Emerging Market Perspectives; Sticking to the Target** - [F&D March 2023: Emerging Market Perspectives; Sticking to the Target (Markdown version)](/-/media/files/publications/fandd/article/2023/march/em-perspectives-villar.pdf.md){rel="alternate" type="text/markdown"} - [F&D March 2023: Emerging Market Perspectives; Sticking to the Target (PDF)](/-/media/files/publications/fandd/article/2023/march/em-perspectives-villar.pdf){rel="external" type="application/pdf"} --- _Source: https://www.imf.org/en/publications/fandd/issues/2023/03/pov-colombia-sticking-to-the-target-leonardo-villar_