- Anchored Inflation Expectations Help Latin America Weather the Oil Shock
As the conflict in the Middle East raises oil prices and threatens another round of inflation, Latin America’s well-anchored inflation expectations are poised to help cushion the impact—even as some major central banks have looked to cut interest rates.
For most countries in the region, post‑pandemic supply shocks have not raised long‑term inflation expectations—what people, businesses, and forecasters expect inflation to be in the years ahead—even amid higher near‑term inflation. Our study shows that these well‑anchored expectations help limit the transmission of energy and other commodity price shocks to consumer prices, because higher import prices today are not expected to translate into persistently higher inflation tomorrow.
The paper builds on earlier IMF work to show how stronger anchoring significantly reduces the inflationary impact of terms‑of‑trade shocks—when the price of a country’s exports changes relative to the price of its imports—in emerging markets. Stable expectations may help policymakers better manage trade-offs in the face of oil price shocks.
Chart showing import price shocks raising inflation where expectations are weakly anchored
Latin America’s major economies now benefit from better‑anchored inflation expectations, the result of institutional reforms begun about 25 years ago. Those changes included adopting inflation targeting, strengthening central bank independence, and ending fiscal dominance.
These reforms helpfully influenced beliefs about prices. Though inflation forecasts in Latin America remain, on average, further from target than in advanced economies, the dispersion in views is similar across both country groups. This is consistent with policymakers who are seen as credible and are operating within frameworks subject to institutional constraints.
Over the past two decades, both tails of the distribution of inflation expectations—views that price increases would be too high or low—have improved. People who once expected inflation to be too high, as well as those who expected it to be too low, have gradually shifted their views toward central banks’ targets.
This hard-earned credibility, however, is also easy to lose. Our paper finds that tighter-than-expected monetary policy can help deliver modest advances in beliefs, increasing anchoring moderately and with a delay. In contrast, unexpectedly loose monetary policy can have much stronger negative effects, leading to expectations losing their anchor.
Case studies from countries such as Brazil, Chile, and Argentina illustrate how changes to monetary policy frameworks affect expectations and offer important lessons for policy design:
The appropriate monetary regime depends on context. For example, although inflation targeting is often a key component of policy regimes which deliver macroeconomic stability, it may not always be ideal when inflation is very high. If inflation is indeed very high, simpler regimes, such as those with exchange rate or monetary targeting components, may initially be more appropriate.
This is not to say that inflation targeting demands perfectly tranquil conditions to be implemented. Though a gradual introduction under stable macroeconomic conditions may appear to be best, inflation targeting can still help anchor expectations even when adopted rapidly in a challenging economic environment. The introduction of inflation targeting in Brazil in 1999 is one such case. In such conditions, though, transparency and accountability are critical to build confidence in the central bank’s policy objectives.
Broad institutional support is essential in almost all cases. Inflation targeting regimes are unlikely to succeed when fiscal or other policies undermine the central bank’s stated objective, or if broader political commitment to low and stable inflation is lacking. High levels of dollarization can add to disinflation challenges.
Latin America’s experience reflects a payoff from reforms a generation ago. Frameworks built around inflation targets and independent central banks helped foster stability and close an era of high and volatile inflation. This progress matters as new shocks emerge, with more-anchored inflation expectations helping to offset temporary price pressures.
The largest disruption in the global oil market’s history poses a new test, but we see a clear pattern: where expectations are well anchored, economies can better absorb such shocks without destabilizing inflation. This ability to weather turbulence comes from monetary credibility built over decades, but it’s not guaranteed. Inappropriately loose policy or abrupt changes to frameworks can quickly erode hard‑won gains, underscoring why preserving credibility remains central to sustaining stability when it matters most.
