The Right Response in Latin America to Oil and Food Price Pressures: Fight Inflation Now!

August 15, 2008

Recent inflationary pressures, especially from oil and food, have clouded the very positive outlook experienced by Latin America since 2004. Although the global sharp increase of oil and food is a worldwide problem, an effective management of inflation is central to Latin America’s capacity to continue on its path of growth and stability. There are two reasons: First, with a reputation for high and hyper-inflation from the 1980s and 1990s, the region’s central banks are being challenged to prove that, this time around, they will do the job right. Second, facing a growing social discontent with the results of democracy and market-based institutions, dealing with oil and food inflation becomes all the more crucial for sustaining the economic and democratic successes achieved so far.

This essay argues that, although the upward trend in the price of oil and food responds to structural factors, the recent acceleration in these prices is mostly a monetary phenomenon associated with the emergence and management of the international financial crisis in industrial countries that started with the U.S. sub-prime crisis in the spring of 2007. The prices of oil and food will continue above their long-term trend until the financial crisis is resolved. This is, of course, bad news for Latin American countries, which are being forced to deal with the effects of a crisis generated by industrial countries’ policies and regulatory deficiencies.

For once, however, Latin America is better positioned to fight inflation than the United States. In contrast to the U.S., most countries in the region can increase interest rates without fearing that their financial system might collapse. But the time of action is now, when the problem is still controllable and concerns about the sustainability of recent gains in many countries are still not making headlines.

A potential silver lining from these developments is that current efforts toward improving the global financial regulatory framework may force industrial countries and international standards setting bodies—which to a large extent comprise multilateral organizations—include proper representation from developing countries. Not doing so would seriously compromise the sustainability of the development process.

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