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Latin America’s central banks, having halted runaway inflation in the late in the later part of the 20th Century, now need greater latitude in their mandates to cope with the economic risks of the 21st Century, most of which are likely to originate outside the region, according to a group of the region’s top finance experts.

My guest on this week’s Wonkcast is CGD senior fellow Liliana Rojas, chair of the Latin American Shadow Financial Regulatory Committee (CLAAF), and our topic is the latest policy statement from CLAAF, which brings together the region’s top economists, mostly former ministers of finance and heads of central banks.

The main focus of the statement, Let the Good Times Roll? Hidden Risks beneath Latin America’s Current Prosperity, is on how the region can be better prepared for future shocks. Top of the list: greater latitude for the region’s central banks.

This recommendation may come as a surprise to those, like me, who remember when Latin America was synonymous with runaway inflation. Throughout most of the second half of the 20th Century, the region had higher inflation than any other part of the world. In several countries chronic high inflation slipped into hyperinflation—price increases greater than 50 percent per month.

Brazil's inflation rate, for example, exceeded 1,000 percent per year in four of the five years between 1989 and 1993. The most notorious case of hyperinflation was Bolivia, which posted a 25,000 annual percent rate in 1984.

In response, many countries set just a single mandate for their central banks: control inflation. In some countries these rules are enshrined in the constitution, in others they are contained in legislation.

“If a financial crisis were to occur, the central banks might not have at its disposal all the necessary tools,” Liliana tells me. "In many Latin American countries, the policy interest rate is viewed as the single monetary policy instrument". 

“We really don't know when something bad could be hitting Latin America. What we are saying to policymakers is: revise the rules now to give your central bank more latitude. They don't need it now but they might need it soon." Liliana adds. "A wider variety of policy instruments, such as liquidity or reserve requirements and counter-cyclical capital provisions should be part of the toolkit of all central bankers in the region and not just a few, such as Peru and Brazil" 

I ask Liliana about the possible risk of a return to the days of chronic high inflation.

“We feel quite comfortable that in a solid group of countries central banks are very well prepared to know exactly what to do to control inflation. That lesson has been learned well.” she says. 

A much more worrisome risk, Liliana suggests, is the incipient emergence of a shadow-banking system, outside the control of regulators, which resembles to some extent the proliferation of non-bank financial institutions in the United States before the 2008 crash.

“Banks in Latin America are extremely well regulated and so they are constrained in their activities,” she explains. “So corporations are funding themselves through alternate means, including issuance of bonds and using credit from retailers; the latter mostly by small firms” Regulators, who have generally done a good job overseeing the banks, need greater authority to oversee such activities, she says.

Another hidden risk for the region: overdependence on commodity exports.

“We are observing that commodity prices are reaching a peak,” Liliana says. Conducting policymaking as if commodity prices were to continue an upward path would be a mistake, she says, since a sudden drop or even a plateau could leave countries short of revenue.

To learn more about these risks—and the actions that CLAAF members recommend taking now to address them, read the 28th CLAAF statement, available here. Disagree or have questions? Post your comment below.