Asymmetric monetary and exchange-rate policies in Latin American countries that use inflation targeting

Abstract

During the last decades, the number of countries that adopted more flexible exchange rate regimes, in particular Inflation Targeting, has been increasing steadily. Latin-America was no exception. Some authors have argued that there is a flaw in the way in which the system has been conducted in the region.When inflation falls, the Central Bank is reluctant to cut interest rates, but when inflation increases, the Central Bank is willing to raise interest rates very aggressively, adding an unnecessary bias to monetary and exchange rate policies. This paper analyzes the asymmetry of monetary and exchange rate policies in the five largest Latin-American Inflation Targeting countries, Brazil, Chile, Colombia, Mexico, and Peru. Using different econometric techniques, I find that the Central Banks, with the exception of Chile, suffer from "fear of floating". This is a more pronounced phenomena for the case of Brazil and Mexico, as the literature has argued. JEL Classification Codes: E58, F30, F43.Markov-Switching Models, GMM, STAR Models.2 my econometric estimation is to test for the presence of asymmetries in the evolution of the exchange rate.But because exchange rate may behave asymmetrically for reasons other than policy, I also estimate a set of Central Bank reaction functions for interest rates and reserve accumulation, to determine the impact of monetary and exchange rate policy on the observed exchange rate behavior.A brief summary of my results is as follows: there are some signs that the Central Banks from Latin-America dislike depreciations more than appreciations, with the exception of Chile. Moreover, this behavior seems to be more pronounced for the cases discussed by Barbosa-Filho and Ros, Brazil and Mexico. This paper is structured as follows. After this introduction, section 3.2 comments on the related literature. Section 3.3 describes the econometric techniques and presents the results. Finally, section 3.4 concludes. Related LiteratureThe recent thinking in macroeconomics have converged on a sort of synthesis, known as the "New Consensus Macroeconomics". This consensus agrees on the desirability of an autonomous monetary policy, and how to conduct it. The interest rate has replaced monetary aggregates on the monetary policy rules. It has been shown that a fully microfounded model based on a representative and forward looking agent framework is able to determine the equilibrium without any reference to the quantity of money, provided that the interest rate rule is sufficiently sensitive to changes in the rate of inflation. This is known as the "Taylor-Principle", and it is embodied in the famous "Taylor-Rule". 2 Intuitively, the principle says that the rate of interest should be increased by more than inflation when inflation increase above the inflation target, to avoid a feedback from higher inflation to lower real interest rates, and from lower real interest rates to more aggregate demand and higher inflation. Conversely, when inflation falls below the target, the interest rate should be reduced by m...

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Contractionary depreciations in Latin America during the 2000s

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