Monetary policy in the Americas
Panel remarks by Mr Alexandre Tombini, BIS Chief Representative for the Americas at the BIS, at the 66th Annual Meeting of the National Association of Business Economists, Nashville, 30 September 2024.
1. The backdrop
We are exiting the period of uncomfortably high inflation. Inflation in all major economies of the Americas has declined significantly over the past two years, but it is generally not yet at target.
The decline in inflation is the result of a series of factors. First, the impact of many of the factors that explain the rise of inflation has largely dissipated. These include the supply disruptions, the rise in commodity prices after the Russian invasion of Ukraine and shifts in demand from services to goods during the pandemic and then back to services after the lifting of lockdowns.
Second, and not less important, central banks reacted forcefully to the surge in inflation. Central banks in Latin America were among the first and most forceful in raising policy rates in response to rising inflation. Their peers in advanced economies waited a bit longer but then acted no less vigorously.
Contrary to many predictions, central banks managed to bring down inflation without choking off the economy – at least so far. The United States appears on track for a soft landing, supported by the recent interest rate cut, and we expect moderate (if lacklustre) growth in most other major economies of the Americas.
2. Where are we now and where are we heading to?
But it is too early to declare victory. Inflation is close to but not yet at target in most countries of the Americas. In some, we have even seen a rebound in inflation. One factor is persistent price increases in the services sector. Wages play an important role. The inflation of recent years has led to an erosion of workers' purchasing power. In the absence of any fundamental factors that would shift earnings from labour to capital, one would expect workers and their representatives to strike a hard bargain to bring real wages back to pre-pandemic levels. In several countries of Latin America, minimum wages are an important driver of the overall wage distribution. Since services tend to have a higher labour content than goods, this could explain why services prices continue to go up.
The slow convergence of inflation to target calls for vigilance in monetary policy. Over the past year, almost all major central banks in the Americas have reduced policy rates. But the monetary policy stance remains restrictive, as ex ante real interest rates are still above central banks' estimates of the neutral rate. A couple of weeks ago, the Central Bank of Brazil even increased its policy rate in response to rising inflation expectations. This probably reflects central banks' reluctance to call a victory before inflation has squarely returned to target.
The last mile of disinflation is likely to be a bumpy one and no easier to navigate than the previous ones, for at least two reasons.
First, policy divergence is becoming more important. The carry trade unwinding of early August is a case in point. My colleagues Matteo Aquilina, Marco Lombardi, Andreas Schrimpf and Vlad Sushko looked at this episode in more detail in a recent BIS Bulletin. The turbulence followed what was perceived as a hawkish rate hike by the Bank of Japan and a somewhat disappointing US job report that market participants interpreted as suggesting that US monetary policy would need to loosen soon. The decline in the rate differentials between investment currencies such as the US dollar, Brazilian real and Mexican peso and funding currencies such as the yen, combined with a sharp increase in market volatility, led to an unwinding of carry trades, with global repercussions. Fortunately, the turbulence in early August turned out to be short-lived and, as importantly, ended without any need for public intervention. But there is no guarantee that something similar will not happen again. Market participants have priced in substantial rate cuts by the Federal Reserve, well above what the Fed's economic projections suggest. At the same time, they have priced in smaller rate reductions in most of Latin America and further increases in Brazil. In this environment, carry trade positions could increase again.
The second factor that could lead to bumps is fiscal policy. Fiscal policy remains quite expansive, and public debt has risen to historically high levels in many countries of the Americas – including here in the United States. This may delay the return of inflation to target. In the medium term, it may limit the space for countercyclical policy and pose important threats to macroeconomic and financial stability. Especially, stretched fiscal positions could make countries more vulnerable to tighter financial conditions. There is evidence that Latin American bond yields are highly responsive to fiscal news. Globally, a 1 percentage point deterioration in the primary surplus (in terms of GDP) is associated with a 4.5 basis point increase in 10-year sovereign yields. In Latin America this effect is 14 basis points.
3. Conclusion
We are entering the last lap in the race against inflation. This last lap will be bumpy. But I am optimistic that central banks in the Americas will be able to navigate these bumps and bring inflation back to target while achieving a soft landing in real activity.
Why am I so optimistic? The first reason is sound policy frameworks and the credibility of the central banks. They tend to have mandates with price stability at their core, and they have the tools, analytical capacity and, no less important, the will to fulfil their objectives.
The second reason for being optimistic is their recent track record. Central banks did not anticipate the flare-up of inflation in the wake of the pandemic and the Russian invasion of Ukraine, but they did react in a timely fashion, forcefully and successfully.
The third reason, which is underappreciated until it stops holding, is that financial systems today are much stronger than they were in the past. The financial crises that plagued Latin America for decades are history, and its banks have much higher capital and liquidity buffers than in the past. Corporate governance, regulation and supervision are also much stronger, from both a macro and a micro point of view. The US financial system is also much more resilient than it was less than two decades ago, not least owing to stricter regulation and supervision.
So, while I foresee bumps in the road ahead, we also have roadworthy cars and alert drivers.
Thank you very much for your attention.
