Ajust after Seven weeks after taking office, Brazil’s leftist President Luiz Inácio Lula da Silva has picked up a row with the central bank. Lula is known to have called the bank’s 13.75% interest rate, the highest in six years, “disgraceful”. He also called the central bank’s independence “nonsense” and suggested that the Senate “keep a close eye” on its governor, Roberto Campos Neto, whose term ends in 2024. The president may even go further, pushing the inflation target — currently at 3.25 percent this year and 3 percent over the next two years — to be raised. After February 16 economist At press time, the National Monetary Council, which sets the target, will be meeting. Lula’s government will also soon have the opportunity to replace the two central bank governors on the Monetary Policy Committee, which sets the bank’s interest rates.
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Lula is not the only Latin American leader putting pressure on central banks. In October last year Gustavo Petro, the newly elected leftist president of Colombia, tweeted: “Is it useful to raise the interest rate to contain inflation? No.” The country’s populist president, Andrés Manuel López Obrador, said the bank should promote economic growth, not just control inflation.
Optimists see this as just politicians venting their fears about the impact of higher interest rates on their popularity. Pessimists worry that such actions could undo Latin America’s enormous economic gains of the past few decades.
At first glance, most Latin American central banks are poster children for fighting inflation. As inflation rises, interest rates rise rapidly. Brazil acted aggressively early, raising rates a full year ahead of the Fed. It raised rates from 2% in March 2021 to 13.75% today. This is one of the strictest policy positions in the world (see Figure 1). That helped bring inflation down from above 12% to 5.8%, the steepest drop in emerging markets.
Likewise, Chile raised interest rates to 11.25% for the 11th consecutive month, higher than market expectations. On Feb. 9, the Bank of Mexico unexpectedly raised interest rates to 11% and indicated that another hike was likely in March. Colombia’s rate was 12.75%, up from 1.75% in 2021. Peru, where anti-government protests have taken place since December, is an exception. On February 9, its central bank stopped raising interest rates after 18 consecutive interest rate hikes, and the current rate is 7.75%. In the US, “we have a debate about the transitory nature of inflation,” says William Maloney of the World Bank. “Latin American Central Bank says: We cannot risk thinking this is not temporary.”
But a closer look reveals signs of tension, and there are two root causes. One is that inflation is sticky and requires sustained high interest rates to control it. While headline inflation is falling in most countries, core inflation, which excludes volatile components such as fuel and food, remains disturbingly high (see Figure 2). Wages are rising faster than productivity growth, which could put further pressure on prices. In Mexico, where nominal wage increases agreed in January averaged 11%, the highest in 22 years, real increases rose sharply. This all means that there is likely to be more pain.
Another problem is that some leaders seem to think that central bank independence is now an issue. They worry that high interest rates will dampen growth and hurt borrowers. The independence of the central bank also makes it harder for these politicians to stimulate the economy, as the banks would offset fiscal expansion.
Independent central banks were once seen as one of Latin America’s great achievements. In the 1970s and 80s, inflation in the region went wild after years of government profligacy. Brazil reaches 2,500%, Peru exceeds 7,500%, and Bolivia exceeds 20,000%. But in 2015-19, the average growth rate across the region was 4%.Today, with the exception of two outliers, Venezuela and Argentina, inflation in the region averages below OECDa club made up mostly of wealthy nations.
Central bank independence is key to beating hyperinflation. This became a consensus between left and right, even though central banks in Latin America became independent later than most. For example, although the Brazilian government has allowed the central bank to operate fairly autonomously since the country returned to democracy in 1985, it was not until 2021 that Lula’s predecessor, Jair Bolsonaro, officially granted the bank independent status .according to International Monetary Fundbanks in the region are now meeting their inflation targets more frequently than banks in other emerging markets.
Independence can be compromised in a number of ways. First, politicians can wield their influence. Brazil’s central bank’s de facto autonomy suffered under Dilma Rousseff, a Lula protégé who was president from 2011 until 2016 be impeached. Her government has put pressure on banks to ease monetary policy. Inflation soared to 10.7% and private sector debt piled up, leading to a disastrous recession.
Personnel changes would also make the central bank more dovish. In a recent note, Goldman Sachs expressed concern that changes to Brazil’s Monetary Policy Council due to term limits could undermine the central bank’s independence if two new directors are brought in for political reasons.By contrast, Mr Petro tried to appease investors in December by nominating Olga Lucía Acosta, the United Nationsto the board of the Central Bank of Colombia.
A third way to erode independence is through constitutional amendments. Chile’s leftist president, Gabriel Boric, 37, has always respected the central bank’s independence. But the constitutional convention he supports seeks to expand the central bank’s remit and potentially weaken its autonomy. (Voters overwhelmingly rejected the final draft of the new constitution in a referendum last year.)
So far, damage has been limited. Bond yields have risen, but that doesn’t suggest that investors are quite panicked. Chile’s central bank remains hawkish, as does Mexico’s central bank. Earlier this month, Colombian central bank governor Leonardo Villar told Bloomberg that monetary policy in the region is likely to remain “restrictive” for some time. In a survey, Brazilians were less likely than the majority to think inflation would rise and more likely to think their standard of living would improve. Still, “we have to be patient until we put the genie back in the bottle,” said Goldman Sachs’ Alberto Ramos. “And not in 2023.” ■
