Inflation and Monetary Policy in Central America, Dominican Republic and Mexico. I. Igal Magendzo Universidad Adolfo Ibáñez October, 2008

Transcripción

1 Inflation and Monetary Policy in Central America, Dominican Republic and Mexico I. Igal Magendzo Universidad Adolfo Ibáñez October, 28

2 Presentation Plan Recent inflation resurge and international prices Estimation of expectations augmented Phillips Curve for each country Output, exchange rates and monetary policy Estimation of equilibrium real exchange rate for each country (Preliminary) monetary policy options

3 Recent inflation resurge and international prices

4 CADM countries (Central America+Dominican Republic+Mexico) have seen a significant resurge in inflation during 28 Average annual inflation: Selected countries and periods Difference World Emerging Nicaragua Panama Dominican 6.6* Guatemala Honduras El Salvador Belize Mexico Costa Rica Commodity price indices (2=1) All Energy All but energy Food * for the DR

5 CADM countries (Central America+Dominican Republic+Mexico) has seen a significant resurge in inflation during Guatemala Belize Nicaragua Costa Rica El Salvador R. Dominicana Panamá México

6 In order to assess the importance of international prices on CADM inflation, we estimate a Phillips Curve for each country Belize Costa Rica Dominican El Salvador Guatemala Mexico Nicaragua Panama Constant (.76) ( 2.54) (7.7) ( 1.83) (1.46) ( 3.54) (2.1) (.89) Expected infl. t (1.19) (3.97) (2.8) (1.68) (.69) (1.91) ( 2.3) (.66) Inflation t (1.55) (8.55) (12.43) (11.75) (5.3) (17.94) (9.59) (3.42) USA CPI inflation.81 (4.21) USA PPI Inflation.18 (4.47) USA PPI Inflation t (.95) (4.43) (.64) (5.8) (1.6) Food inflation.2 (1.18) Food inflation t (1.74) (2.38) (1.93) (1.37) Food inflation t 2.6 (3.31) WTI inflation.2 (3.93) WTI inflation t 2. (.6) Output gap (.45) (2.44) (2.8) (.41) (4.54) ( 1.93) (4.47) MA ( 4.2) ( 24.25) ( 44.41) ( 8.1) ( 6.61) ( 19.) ( 4.68) R squared Adjusted R squared Sample begins 2Q2 1992Q1 1992Q1 1992Q1 1996Q3 1992Q1 1995Q2 2Q2

7 Our calculations indicate that the recent surge in inflation is mainly, but not uniquely, due to foreign exogenous factors Belize Dominican Costa Rica El Salvador Guatemala Mexico Panama Δ Inf 28Q2 27Q External factors (share) (59.5) (5.) (42.9) (66.) (23.) (312.7) (36.1) Of which: USA inflation Food inflation OIL inflation

8 Inflation expectations have increased substantially lately. Results from our Phillips Curves indicate that inflation is relatively persistent in CADM countries (low credibility) Expected inflation for Dec. 28 (latest data) Consensus Survey Costa Rica 14.1 Dominican 12.4 Guatemala 12.2 Honduras 13.4 Mexico 5.7 Panama 9.4 Phillips Curve Parameters Belize Costa Rica El SalvadorGuatemala Mexico Nicaragua Panama Dominican Expected inflation in t (1.19) (3.97) (1.68) (.69) (1.91) ( 2.3) (.66) (2.8) Inflation t (1.55) (8.55) (11.75) (5.3) (17.94) (9.59) (3.42) (12.43)

9 There has also been an increase in prices excluding food and energy. This is likely to be, at least in part, the effect of propagation of external shocks to domestic prices Core Inflation, % change y.o.y México Belice Guatemala Costa Rica El Salvador

10 Output, exchange rates and monetary policy

11 Low credibility also translates in high costs of reducing inflation: need to generate big output gaps Output gap or appreciation needed to reduce inflation by 1% in ayear Belize Costa Rica El Salvador Guatemala Mexico Nicaragua Panama Dominican Output Gap n.a n.a 6.9 n.a Appreciation

12 As opposed to South American countries where there has been an appreciation of the currencies, in CADM countries the Exchange rate has not help to alleviate inflationary pressures. Dollar exchange rate depreciation from different dates to latest data Costa Rica República Dominicana Guatemala México Nicaragua Brasil Chile Perú

13 Our preliminary evidence indicates that real exchange rates are overvalued in most countries % difference of RER in 28 and selected dates RER undervaluation in Misal ignment 28 X-rate regime Guatemala -25,2% Managed Nicaragua -14,2% Crawling El Salvador -13,7% Dollarized Honduras -11,5% Crawling Costa Rica -4,4% Crawling Mexico 6,7% Float Dominican 7,8% Float Panama 13,4% Dollarized 2 C.Rica Nicaragua R.Dominicana Guatemala Honduras Panama El Salvador Belice

14 In recent years GDP growth in CADM countries has been relatively high and output gap seems to be positive Belize Average anual GDP growth, selected periods (%) Costa Rica El Guatema DominicanSalvador la Honduras Mexico Nicaragua Panama Difference Averge output gap, selected periods Belize Costa Rica El Salvador Guatemala Mexico Nicaragua Panama Domin. Rep

15 Most CADM countries pursued a somewhat expansionary monetary policy. Domestic credit continued to grow since 27 Selected Indicators of Monetary Policy (change between January 27 and latest data) Reference Interest rates Money base International Reserves Domestic credit 27 curr. acc. bps (aprox) % annualized mill. USD % change % change mill USD Costa Rica , Mexico ,742 Panama n.a. -1,343 Belize Nicaragua ,254 Honduras ,59 Guatemala ,379 El Salvador ,38 Dominican ,231

16 (Preliminary) monetary policy options

17 Monetary policy options Because of the current international crises, CADM countries face a negative external demand and credit shock Ideally, monetary policy should be used to mitigate the shock, i.e. expansionary MP BUT, MP in CADM face a dilemma between current inflationary pressure, low credibility and the negative shock This dilemma is likely to disappear over time, but MP does not have the freedom for early action If monetary policy is eased too early there is a risk of loosing the nominal anchor Countries with a pegged exchange rate have to bear the higher international interest rates

18 Monetary policy options Recommendations: Continue strengthening the MP framework Wait for international and internal prices to go down (and their effect on expected inflation) Help expectations to go down with active communication (avoid panic!) When expected inflation starts to ease, begin NEW expansionary cycle DO NOT GIVE UP ON THE NOMINAL ANCHOR, YOU MAY NEED CREDIBILITY TO FIGHT RECESION AND EVEN DEFLATION