Inflation is certainly not new to the region, but unlike the well‐known episodes of the past, most Latin American governments now employ good fiscal discipline, maintaining low budget deficits and soaring tax revenues.
So where is inflation coming from? Back in the 1980s and early 1990s, it was fueled by the severe fiscal imbalances of regional governments. As public spending grew exponentially and revenues stagnated or even declined, Latin American politicians turned to central banks to feed their binge. The result was catastrophic: hyperinflation devastated Argentina, Bolivia, Peru, and Nicaragua. National currencies collapsed and were replaced with short‐lived new ones.
Today, the outlook is quite different. Latin American governments are enjoying a rare fiscal bonanza. Most countries have small budget deficits or even surpluses. External debt is generally under control, and foreign reserves are steadily increasing.
But the export boom, and the flow of dollars that’s fueling it — along with a surge in foreign direct investment and remittances from nationals living abroad — has had an unwelcome consequence, at least in the mercantilist view that still prevails in much of the region.
Every Latin American currency except the Argentinean peso appreciated against the dollar in 2007, in some cases by almost a quarter: the Uruguayan peso jumped by 23.5 percent, the Brazilian real by 23 percent, and the Colombian peso by 22.1 percent. The Peruvian sol, the Paraguayan guarani and the Chilean peso each also appreciated by more than 10 percent last year.
Currency appreciation has generated grievances from exporters who complain that their products are becoming less competitive in international markets. Latin American manufacturers are already facing strong competition from China, and many claim that their economies are suffering from “Dutch disease” — that is, high commodity prices that hurt the manufacturing sector by raising the exchange rate, making exports more expensive.
This has led state monetary authorities to intervene heavily in currency markets in order to keep their exchange rates “competitive” — that is, artificially low. The central banks of Argentina, Colombia, Peru, Bolivia, Costa Rica, and Guatemala, among others, have all purchased billions of dollars in an effort to prevent their national currencies from further appreciation. Central banks have pumped up their economies with extra money, which is in turn pushing up prices.