A Comparison of Product Price Targeting and Other Monetary Anchor Options for Commodity Exporters in Latin America

In perhaps no other region have attitudes with respect to nominal anchors for monetary policy evolved more than in the developing countries of the Western Hemisphere.

Inflation rates went very high in the early 1980s—to hyperinflation in some cases (for example, Argentina, Bolivia, Brazil, and Nicaragua). As a result, the need for a nominal anchor was apparent. In a nonstochastic model, any nominal variable is as good a choice for monetary anchor as any other. But in a stochastic model, and moreover in the real world, the nominal variable that monetary authorities choose and publicly commit to in advance makes quite a difference.¹ Should it be the money supply? Exchange rate? CPI? Other alternatives? The question of which nominal variable to choose is the subject of this paper.

When stabilization was finally achieved in the countries of Latin America and the Caribbean (LAC) in the 1980s and early 1990s, the exchange rate was virtually always used as the nominal anchor with which to build the successful stabilization programs. This was true whether it was Chile’s tablita, Bolivia’s exchange rate target, Argentina’s convertibility plan, or Brazil’s real plan. But matters have continued to evolve.

The Trend from Exchange Rate Targeting to Inflation Targeting

The series of emerging market currency crises that began in Mexico in December 1994 and ended in Argentina in January 2002 all involved the abandonment of exchange rate targets in favor of more flexible currency regimes, if not outright floating. In many countries (including Mexico and Argentina) the abandonment of a cherished exchange rate anchor for monetary policy took place under the urgent circumstances of a speculative attack. A few countries (Chile and Colombia) made the jump preemptively to floating before a currency crisis could hit. Only a very few smaller countries responded to the ever rougher seas of international financial markets by moving in the opposite direction, to full dollarization (Ecuador, under pressure of crisis; and El Salvador, out of longer-run motivations). In the thirty-year time span, the general trend has been toward increased flexibility.²

With exchange rate targets somewhat out of favor by the end of the 1990s, and the gold standard and monetarism³ already relegated to the scrap heap of history, there was an obvious vacancy for the position of preferred nominal anchor or intermediate target for monetary policy. (The table in appendix A summarizes the Achilles heel of monetarism, the gold standard, and each of the other variables that have been proposed as candidates for nominal target.)

The regime of inflation targeting (IT) was a fresh young face, arriving with an already-impressive résumé of recent successes in wealthier countries (New Zealand, Canada, United Kingdom, and Sweden). In many emerging market countries around the world, IT got the job of preferred nominal anchor. Three South American countries—Brazil, Chile, and Colombia—officially adopted inflation targeting in 1999 in place of exchange rate targeting.⁴ Mexico had done so earlier, after the peso crisis of 1994–95. Peru followed suit in 2002, switching from an official regime of money targeting. Guatemala has officially entered a period of transition to inflation targeting, under a law passed in 2002.

In many ways inflation targeting has functioned well. It apparently anchored expectations and avoided a return to inflation in Brazil, for example, despite two severe challenges: the 50 percent depreciation of early 1999 as the country exited from the real plan; and the similarly large depreciation of 2002, when a presidential candidate who, at the time, was considered antimarket and inflationary pulled ahead in the polls.⁵

One could argue, however, that events of recent years, particularly the global financial crisis of 2008–09, have put strains on the inflation-targeting regime much as the events of 1994–2001 had earlier put strains on the regime of exchange rate targeting. Three other kinds of nominal variables, besides the CPI, have forced their way into the attention of central bankers. One nominal variable, the exchange rate, was never really forgotten—certainly...