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Latin America’s Monetary-Policy Test

SANTIAGO – On matters of sex, the citizens of mostly Roman Catholic Latin America often proclaim one thing and practice something very different. On matters of monetary policy, Latin central banks often also fail to live up to what they preach.

In theory, monetary authorities in Brazil, Chile, Colombia, Mexico, Peru, and Uruguay adhere to the modern orthodoxy of inflation targeting, which holds that price stability is the main (perhaps the only) goal of monetary policy, the short-term interest rate should be the only instrument used to achieve the inflation target, and the exchange rate ought to float freely.

But the actual practice of all six central banks bears only a passing resemblance to this orthodoxy. To begin with – and not surprisingly for export-led economies – the real exchange rate is also an (implicit) target for monetary policy. As a result, interventions in foreign-exchange markets have been lasting and widespread, even in countries like Chile and Mexico, which explicitly vowed to let their currencies float freely. Some countries – most notably Brazil – have also used taxes on international capital flows and other kinds of controls in an effort to guide the currency’s value.

The deviations from standard inflation targeting do not stop there. Colombia, Peru, Brazil, and other countries in the group have also used a range of unconventional policy tools – especially changes in reserve requirements for bank liabilities of varying maturities and currency denominations – to manage liquidity and credit.