Monetary Policy and Inflation Expectations in Latin America

The current monetary policy framework in several Latin American countries, combining inflation targeting anda floating exchange-rate regime, has contributed to disinflation by anchoring expectations around low, stablelevels. This paper uses co-integration analysis to estimate simultaneously a monetary reaction function and thedeterminants of expected inflation for Brazil, Chile, Colombia and Mexico in the post-1999 period. It also testsfor the presence of volatility spillovers between the monetary stance and inflation expectations based onM-GARCH modelling. The results of the empirical analysis show that: i) there are long-term relationshipsbetween the interest rate, expected inflation and the inflation target, suggesting that monetary policy has beenconducted in a forward-looking manner and helped anchor inflation expectations in the countries underexamination, and ii) greater volatility in the monetary stance leads to higher volatility in expected inflation inBrazil, Colombia and Mexico, suggesting that interest-rate smoothing contributes to reducing inflationexpectations volatility. No volatility spillover effect was detected in the case of Chile.