Latin America Economic Perspectives: Shifting Gears in an Age of Heightened Expectations

INTRODUCTION AND SUMMARY 

Overheating and inflationary pressures in Latin America are rising, and many financial regulators wonder whether domestic credit is already growing excessively. On the fiscal front, the region is now facing the well-known fact that tightening during an upturn is harder than loosening during a recession. On the monetary side, the simplistic inflation targeting is being replaced by a combination of targets and ad hoc instruments. Financial stability, or bubble prevention, is the most recent addition to new set of targets. In terms of the toolkit, prudential macroeconomic rules have gained status as an instrument to deliver financial stability.

Bringing macroeconomic stability back by relying exclusively on monetary policy will be too costly. The necessary increase in interest rates will only create more upward pressures on exchange rates, fostering a never-ending destabilizing spiral. If only for this reason, fiscal unwinding is indispensable for economies to return to normalcy.

While intervention and controls have often been framed in a negative light, they are increasingly seen as a useful complement to countercyclical macroeconomic policy toolkit. Sterilized interventions have gradually become the rule, and recent years have seen a comeback of reserve requirements, not only selectively as a tax on inflows but also uniformly as a monetary policy tool to raise lending interest rates without enhancing the appeal of carry trades.