Fighting inflation

Latin America is running out of policy tools to fight persistent inflation.

The rate of inflation across Latin America reached its highest levels in decades in the first half of 2022. The perfect storm has been created by the global effects of the Ukraine War and other geopolitical tensions, coupled with declining global demand, high levels of public debt and political instability.

A senior regional economist commented, “The current situation is very dangerous and inflationary pressures may still increase further. Indeed, the rise in interest rates in the United States of America strengthens the US dollar, which implies a significant increase in the cost of imports for Latin American countries. Rising interest rates also restrict access to external credit and make servicing debt more expensive for both government and private entities, putting further pressure on local currencies.”

“The current situation is very dangerous and inflationary pressures may still increase further.”

Senior regional economist, Venezuela

Smaller economies are being hit harder by inflation due to their limited diversification, greater reliance on imports and higher public debt. Thus, Central America, the Caribbean and smaller economies in South America including Bolivia, Ecuador, Paraguay and Uruguay are facing serious difficulties in controlling inflation.

In parallel, economies with structural deficiencies like Argentina and Venezuela are registering unprecedented inflationary trends – monthly inflation in Argentina was over 7% in August, reaching 80% compared to the previous year. President Alberto Fernández has tried to freeze prices for specific products, and rationed the sale of products like sugar, milk and flour. In parallel, the Minister of Economy Sergio Massa has announced the withdrawal of energy subsidies and higher bank interest rates, among other measures in an attempt to control rising consumer prices, which are 56.5% higher than in 2021.

In Venezuela, where monthly inflation increased to 8.2% in the month of August, reaching 114.1% year-on-year, President Nicolás Maduro is fighting consumer price growth by increasing supplies of foreign currency in local banks, restricting the expansion of credit, reducing public spending and imposing higher taxes.

“Whenever there is an inflationary problem, politicians come up with price controls. This is the worst remedy.”

Senior regional economist, Venezuela

The regional economist was adamant that price controls were not the answer, “Whenever there is an inflationary problem, politicians come up with price controls. This is the worst remedy because price controls, even temporary ones, always generate shortages and rationing. Any mechanism that seeks to alleviate the effects of inflation on consumers must avoid government intervention on prices because this distorts the functioning of the economy and avoids the readjustment that occurs the reallocation of resources in the market.”

A professor of economics at a Mexican university ambitiously hoped for long-term change, “The solution to the problem of inflation in Latin America lies in strengthening the institutional framework of its countries so that competent authorities can seriously develop the necessary policies to control price increases, without giving in to the populist pressures of politicians.”

The reality is that Latin American countries hit harder by rising inflation have limited policy tools at their disposal. In this context, even the International Monetary Fund recommends to adjust domestic prices to international prices while providing support for the most vulnerable; apply price smoothening mechanisms with clear exit strategies; and implement spending measures to limit overall fiscal impact.

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