Central banks in the Americas: steadfast in the face of a global shock

Keynote dinner speech by Mr Agustín Carstens, General Manager of the BIS, at the 20th Anniversary High-Level Conference of the BIS Americas Office, Mexico City, 20 November 2022.

BIS speech  | 
20 November 2022


We gather at a time when central banks in the Americas are facing the highest inflation in decades. Inflation rose around the globe and took many by surprise.

Getting inflation back to target is crucial. Failing to act now would result in even starker trade-offs in the future and would squander the hard-earned credibility that central banks have built up over decades. Moreover, high inflation has substantial social costs. Inflation hits the poorest hardest. They tend to spend a larger share of their income and spend more on food and energy. They have – almost by definition – vulnerable personal finances and little access to financial products or other contracts that protect them against rising prices.

The key question facing us today is: are central banks willing to bring down inflation? The answer in a word is: yes. Central banks in Latin America acted earlier than most of their peers around the world and tightened interest rates substantially. The Bank of Canada and the Federal Reserve have moved forcefully. Clearly, central banks are committed to achieving their mandates.

The willingness is there, but how about the ability? Again, the answer is yes. Central banks have the tools and can build on much stronger policy frameworks than in the past. This is especially the case in Latin America, which has emerged from very high rates of inflation in decades past with policy experience that can inform not only their own actions, but those of others.

A global inflationary shock

Certainly, large supply-side shocks are not new to many of us, nor are shocks to salient prices that threatened to de-anchor long-term inflation expectations. For example, in 2010 and 2015, the El Niño weather phenomenon affected harvests in Colombia and Peru, leading to sharp increases in the prices of fruit and vegetables. In 2011 and 2017 we had in Mexico what private analysts called the "pico de gallo effect" since onions and tomatoes registered a sharp increase in their prices. This also affected avocados and guacamole - a key appetiser in any Mexican meal. We also had a large increase in tortilla prices in 2007. The same happened with tomato prices in Brazil in 2005 and 2013, and so on. Yet these shocks were "easy" compared with what we face today. They were straightforward relative price changes, since relatively few items of the CPI basket were affected. Explaining to the public the nature of a supply shock and its short-run arithmetic effect on annual inflation was simpler.

Indeed, today's inflation differs quite significantly from the inflationary episodes that we have seen over the past decades.

First of all, the current surge in inflation is global. While the amount of inflation varies, there are very few countries in which prices did not go up substantially. This points to the importance of global drivers of inflation. These include supply restrictions in the wake of the pandemic, a quicker-than-expected recovery after the lockdowns and higher commodity prices.

Second, the diffusion of inflation has also been very similar across countries. At the beginning it was only a few goods or services that were recording outsized price increases – US used cars being one example. These price increases could easily be ascribed to temporary and idiosyncratic factors – the downsizing of rental fleets and semiconductor shortages in case of car production. But this changed as more and more goods and services recorded significant price increases.

Third, the rise in inflation had an important supply-side element. Restarting global supply chains has been much, much harder than shutting them down and much harder than most had anticipated. That said, it would be wrong to ascribe the surge in inflation entirely to supply-side factors: the faster-than-anticipated recovery of the global economy given massive fiscal and monetary policy stimulus surely contributed as well.

Fourth, as soon as one set of shocks had worked its way through the economy another one appeared. Commodity and energy prices had already gone up reflecting the stronger-than-expected recovery and limited supply when the fallout of Russia's invasion of Ukraine drove them up even further.

These factors distinguish the recent rise in inflation form earlier episodes, which tended to be more localised and mainly demand-driven. One has to go back to the surges in inflation during the oil crises of 1973 and 1979 to find similarly global inflationary episodes.

If the surge in prices is global, what can monetary policy do to bring down inflation? Fortunately, a fifth characteristic of the current episode helps: the rise in inflation has led to a global monetary policy response. Latin American central banks may have been among the first to raise interest rates, but they were not the only ones. Central banks around the globe have tightened policy, with only a few exceptions. This global response to a global phenomenon should make it much easier to reduce inflation.

Another attenuating factor is that long-term inflation expectations have generally remained anchored even as short and medium-term expectations rose. This is even the case in most Latin American countries, where inflation was once endemic. This is where strengthened policy frameworks are paying dividends. In general, central banks in the Americas have converged on monetary policy frameworks with independent central banks, clear mandates with price stability at their core and flexible exchange rates.1 This has paid off handsomely. Between 1980 and 2000, inflation in Latin America averaged 384% per year. In the following 20 years, between 2001 and 2021, the corresponding rate was only 6.7%.2 

Disinflation will be hard but achievable

Consensus forecasts suggest that analysts expect a relatively smooth and linear disinflation process. I believe that this is very optimistic, perhaps too optimistic. Inflation appears to have peaked in some economies in the region and may be close to peaking in others, but it has a long way to go before reaching a level the population is comfortable with, not to mention the central banks' objectives.

True, base effects will fall out of the 12 months over which we tend to compute inflation rates. Supply restrictions should also ease and the impact of receding energy and food prices should be felt. All this will reduce headline inflation – unless new shocks drive it up again, as happened in the past year or so.

But in parallel, persistence effects from formal and informal indexation and higher inflation expectations are likely to kick in. Note that core inflation remains quite elevated, and in some countries continues to rise. Moreover, some of the tailwinds that contributed to low inflation in the last three decades, for instance deepening globalisation, technological advances and demographic factors, may not be as strong in the future or may even reverse.3 This suggests that the second phase of the disinflation process could be quite tough and protracted.

Then there is the risk that activity slows down significantly before inflation does so. This could put pressure on central banks to shift their focus to growth before disinflation has been achieved. I believe that yielding to such pressures would be undesirable. It is my belief that central banks contribute the most to growth in the medium and long term by bringing inflation back to target as soon as feasible.

Another risk is stretched fiscal balances. Monetary policy has been pulling the brakes significantly since 2021. Fiscal policy has also tightened, but many countries still run primary deficits, so the stance is still stimulative. Subsidies for fuel and food have helped to contain inflation in many countries and surely have helped to reduce the probability of shifting to a high inflation regime. But these measures could be difficult to sustain and reverse, and could turn into a barril sin fondo­ – a barrel without a bottom. This could drive up risk premia, and result in a further tightening of financial conditions.

Instead of stoking demand, scarce fiscal resources should be used to tackle supply constraints head-on. Governments should address supply constraints due to climate change, ageing populations and infrastructure through growth-friendly actions and support for broad structural reforms. Such a focus on reinvigorating growth through the supply side could also create scope to rebuild fiscal buffers.

Let me conclude. The challenges that central banks are confronting are formidable. Meeting them will require good analysis, sound judgement, a thick skin and a lot of work. Yet thankfully, central banks are not alone. We have one another. And the BIS, which has walked this road with central banks in the Americas for two decades now, will continue to do so.

With the Americas Office, the BIS will remain physically present in the Americas region. This is a tangible marker of our commitment to our shareholders and the broader central bank community. Through the Americas Office, the BIS will continue to support high-level policy dialogue and cooperative activities; cutting-edge research, including on the policy challenges I've just sketched; a range of high-quality banking services for central banks; and now – through the BIS Innovation Hub – digital public goods for the central bank community.

1      A Tombini, A Aguilar and F Zampolli (2023), "Monetary policy frameworks in Latin America: evolution, resilience and future challenges" in C Borio, E Robinson and H S Shin (eds), Macro-financial Stability Policy in a Globalised World: Lessons from International Experience, Singapore: World Scientific Publishing Company.  

2      Average for the 6 CCA countries in Latin America (Argentina, Brazil, Chile, Colombia, Mexico and Peru), weighted by GDP at PPP. 

3       A Carstens (2022), "A story of tailwinds and headwinds: aggregate supply and macroeconomic stabilisation", speech at the Jackson Hole Economic Symposium, 26 August.