J U N E 2 0 0 8

L A T I N A M E R I C A ´ S I N F L A T I O N

Alfredo Thorne, MD, Global Economics Department

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Agenda

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B C R P - W O R L D B A N K S E M I N A R , L I M A , P E R U , 1 6 - 1 7 J U N E , 2 0 0 8

Latam inflation.ppt

A final comment

Investigating Mexico’s reaction function

Searching for a rationale of external shocks

Surprises on inflation and growth

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Latam inflation.ppt

-1

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1

2

3

4

5

6

7

8

9

2002 2003 2004 2005 2006 2007 2008

Emerging Markets

Developed Markets

Inflation is accelerating in both developed and emerging market economies (%3m/3m, saar)Inflation is accelerating in both developed and emerging market economies (%3m/3m, saar)

Source: JPMorgan

Global and EM inflation has accelerated

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Latam inflation.ppt

-1

0

1

2

3

4

5

6

7

8

9

2004 2005 2006 2007 2008

Food

Energy

Global consumer prices (%oya)Global consumer prices (%oya)

Source:JPMorgan

Mostly induced by food and energy components

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Latam inflation.ppt

2008

4Q07 1Q08 2Q08Q 3Q08 4Q08 %Dec/Dec TargetBrazil 4.3 4.6 5.2 5.2 5.1 5.5 4.5(+2

Chile 7.2 8.0 8.0 6.0 5.0 4.7 3.0(+1

Colombia 5.4 6.1 5.9 5.5 5.2 5.6 3.5 -4

Ecuador 2.8 5.3 7.5 7.0 6.9 8.0 2.4-2.

Mexico 3.8 3.9 5.0 4.9 4.5 4.5 3(+1

Peru 3.5 4.7 5.2 4.7 4.3 4.6 2.0(+1

Venezuela 20.2 26.2 29.3 31.4 30.0 28.0 19.5

Latin America: CPI inflation-forecasts and targets (%oya, quarterly average)Latin America: CPI inflation-forecasts and targets (%oya, quarterly average)

*Forecast is for official inflation measure (JPMorgan estimates of actual rate for April 2008 is 24%oya).Source: JPMorgan

Latin American inflation is well above their targets

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Latam inflation.ppt

% share of CPI basket: % of Jan-May CPI inflation explain

Food* Energy Food* Energy

Argentina 31.3 12.3 39.4 8.9

Brazil 22.0 9.5 46.4 -1.9

Chile 27.2 11.1 58.2 -2.0

Colombia 29.7 3.2 56.2 4.6

Mexico 22.7 7.9 68.5 -29.6

Peru 47.5 6.2 91.2 -3.7

Venezuela 29.6 7.0 43.5 -

Latin America 25.2 8.6 56.7 -11.8

Latin America: food and energy in CPI basketsLatin America: food and energy in CPI baskets

*Includes food and beverages consumption at home and in restaurants, excludes tobacco. For Venezuela and Mexico this include tobacco (within alcoholic beverages and tobacco category) and hotel services (within hotels and restaurants category)

Source: JPMorgan

Food and energy account for most of the inflation acceleration

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Latam inflation.ppt

EE

Source: JPMorgan

However, most countries subsidize fuel prices

Country Are oil price subsidized?

Who bears the cost of the subsidy

Has the subsidy risen in the past 12-

18months? Are there plans to

reduce the subsidy? Domestic prices of gasoline US$/liter

Net oil exporters

Argentina Yes Private companies Yes No 0.80

Colombia Yes State oil company Yes Yes, reduction under way

1.07

Ecuador Yes State oil company Yes No 0.38

Mexico Yes Government Yes, significantly Yes 0.71

Venezuela Yes State oil company - No definite plans 0.04

Net oil importers

Brazil Yes State oil company Yes No 1.53

Chile Yes State oil company Yes No 1.20

Peru Yes Stabilization fund Yes Yes 0.87

Most Emerging Markets countries subsidize domestic oil prices-net exporters and importers alikeMost Emerging Markets countries subsidize domestic oil prices-net exporters and importers alike

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Latam inflation.ppt

EM breakeven inflation has increased since the beginning of the yearEM breakeven inflation has increased since the beginning of the year

Source: JPMorgan

And markets are pricing future long term inflation

Short end Long end

Tenor Rate (%) Change (bp) Tenor Rate (%) Change (bp)

Latin America

Brazil 1-year 5.33 -4 10-year 5.57 35

Chile 1-year 5.23 133 10-year 3.98 40

Mexico 1-year 4.55 21 10-year 4.09 -13

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Latam inflation.ppt

Inflation forecasts moving up in EMInflation forecasts moving up in EM

Source: JPMorgan

Inflation has been the main surprise…

2008 2009

Country End-April Current Forecast

revision (%point) End-April Current Forecast revision

(%point)

Latin America

Brazil 4.7 5.5 0.8 4.5 4.8 0.3

Chile 4.5 5.5 1.0 3.1 3.5 0.4

Colombia 5.0 5.6 0.6 4.0 4.5 0.5

Ecuador 5.3 8.0 2.7 4.0 4.0 0.0

Mexico 3.6 4.5 0.9 3.3 3.3 0.0

Peru 4.1 4.6 0.5 3.0 3.0 0.0

Venezuela 30.0 28.0 -2.0 29.9 29.2 -0.7

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Latam inflation.ppt

JPMorgan’s forecast for EM countries growth in 2008 to remain unchangedJPMorgan’s forecast for EM countries growth in 2008 to remain unchanged

Source: JPMorgan

…while on growth the forecasts have experienced limited changes

2008 2009

Country End-April Current Forecast

revision (%point) End-April Current Forecast revision

(%point)

Argentina 6.5 6.5 0.0 5.0 3.0 -2.0

Brazil 4.4 4.4 0.0 4.0 4.0 0.0

Chile 3.5 3.5 0.0 5.0 5.0 0.0

Colombia 5.0 5.0 0.0 5.0 5.0 0.0

Ecuador 2.5 2.5 0.0 2.5 2.5 0.0

Mexico 2.6 2.6 0.0 4.5 4.0 -0.5

Peru 7.0 7.7 0.7 6.0 6.0 0.0

Venezuela 6.0 3.5 -2.5 3.5 3.5 0.0

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Latam inflation.ppt

JPMorgan’s policy rate forecast changes since end-AprilJPMorgan’s policy rate forecast changes since end-April

Source: JPMorgan

This explains the recent revision in policy stance

End-2008 rate forecasts

Country Official interest

rate Current rate Current forecast End-April Forecast r

(%poinBrazil SELIC overnight rate 12.25 14.00 13.00 100

Chile Discount rate 6.75 7.0 5.75 125

Colombia Repo rate 9.75 10.00 9.75 25

Mexico Policy rate 7.50 8.0 7.00 100

Peru Reference rate 5.75 6.00 5.50 50

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Agenda

Page

B C R P - W O R L D B A N K S E M I N A R , L I M A , P E R U , 1 6 - 1 7 J U N E , 2 0 0 8

Latam inflation.ppt

A final comment

Investigating Mexico’s reaction function

Searching for a rationale of external shocks

Surprises on inflation and growth

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27

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Latam inflation.ppt

3

3.5

4

4.5

5

5.5

6

6.5

7

Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07

Headline

Core

Source: Country data Source: IBGE

Latam inflation rates (%oya, Bra, Mex, Chi, Per)Latam inflation rates (%oya, Bra, Mex, Chi, Per) Brazil inflation rates (%oya)Brazil inflation rates (%oya)

Food has driven Latin inflation

-4

-2

0

2

4

6

8

10

12

14

Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07

Headline

Food and beverages

Official core

12SE

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Latam inflation.ppt

2

3

4

5

6

7

8

9

10

Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07

Core food

Core

Headline

Source: Banxico Source: INE

Mexico’s inflation (%oya)Mexico’s inflation (%oya) Chile’s inflation (%oya)Chile’s inflation (%oya)

Brazil and Chile have experienced that strongest shocks

-5

0

5

10

15

20

25

Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07

Food

Headline

Core

13SE

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IN

GF

OR

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Latam inflation.ppt

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

01Q1 02Q3 04Q1 05Q3 07Q1 08Q3

BrazilG-7

US

Source: JPMorgan Chase Source:JPMorgan Chase

Brazil: Deviation of real GDP growth (from 5-year moving average)

Brazil: Deviation of real GDP growth (from 5-year moving average)

Mexico: Deviation of real GDP growth (from 5-year moving average)

Mexico: Deviation of real GDP growth (from 5-year moving average)

Business cycles have diverged—Mexico is more in sync with the global economy and Brazil much less

-1

-0.5

0

0.5

1

1.5

2

2.5

3

01Q1 02Q3 04Q1 05Q3 07Q1 08Q3

Mexico

G-7

US

14SE

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Latam inflation.ppt

0.90

0.92

0.94

0.96

0.98

1.00

1.02

1.04

1.06

1.08

2004 2005 2006 2007 2008

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

IMF non-fuel primary commodity index

Mexico REER

Source: JPMorgan and IMF

Mexico: Deviation REER and IMF non-fuel primary commodity index (from 5-year moving average)

Mexico: Deviation REER and IMF non-fuel primary commodity index (from 5-year moving average)

Brazil: Deviation REER and IMF food commodity index (from 5-year moving average)

Brazil: Deviation REER and IMF food commodity index (from 5-year moving average)

Surprising REER have not been as closely correlated with commodity prices

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

2004 2005 2006 2007 2008

1.00

1.10

1.20

1.30

1.40

1.50

1.60

Brazil REER IMF food commodity index

Source: JPMorgan and IMF

15SE

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OR

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Latam inflation.ppt

1.00

1.05

1.10

1.15

1.20

1.25

2004 2005 2006 2007 2008

1.10

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

IMF metal commodity index

Chile REER

Source: JPMorgan and IMF

Chile: Deviation REER and IMF metal commodity index (from 5-year moving average)

Chile: Deviation REER and IMF metal commodity index (from 5-year moving average)

Peru: Deviation REER and IMF metal commodity index (from 5-year moving average)

Peru: Deviation REER and IMF metal commodity index (from 5-year moving average)

0.90

0.92

0.94

0.96

0.98

1.00

1.02

1.04

1.06

1.08

1.10

2004 2005 2006 2007 2008

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

Peru REER

IMF metalcommodity index

Source: JPMorgan and IMF

16SE

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IN

GF

OR

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This is mostly apparent in Chile and Peru

B C R P - W O R L D B A N K S E M I N A R , L I M A , P E R U , 1 6 - 1 7 J U N E , 2 0 0 8

Latam inflation.ppt

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2004 2005 2006 2007 2008

-20

-10

0

10

20

30

40

IMF food commodity index

Deviation from inflation target

%oya %oya

1. Deviation from Banxico’s 3% (+/-1%) official target.Source: JPMorgan and IMF.

Brazil: inflation deviation from target and IMF food commodity index (from 5-year moving average)

Brazil: inflation deviation from target and IMF food commodity index (from 5-year moving average)

This had a side effect on overall inflation

-2

-1

0

1

2

3

4

2004 2005 2006 2007 2008

-20

-10

0

10

20

30

40

Deviation from inflation target

IMF food commodity index

%oya %oya

1. Deviation from Central Banks 4.5% official target.Source: JPMorgan and IMF.

Mexico: inflation deviation from target and IMF food commodity index (from 5-year moving average)

Mexico: inflation deviation from target and IMF food commodity index (from 5-year moving average)

17SE

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IN

GF

OR

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Latam inflation.ppt

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2004 2005 2006 2007 2008

-10

-5

0

5

10

15

Deviation from inflation target

REER (inverted scale)

%oya %oya

FX intervention may have limited the low inflation gains

-2

-1

0

1

2

3

4

2004 2005 2006 2007 2008

-15

-10

-5

0

5

10

15

20

25

30

REER (inverted scale)

Deviation from inflation target

%oya %oya

Mexico’s inflation deviation from target and REER (from 5-year moving average)

Mexico’s inflation deviation from target and REER (from 5-year moving average)

Brazil’s inflation deviation from target and REER (from 5-year moving average)

Brazil’s inflation deviation from target and REER (from 5-year moving average)

1. Deviation from Banxico’s 3% (+/-1%) official target.Source: JPMorgan and IMF.

1. Deviation from Banxico’s 3% (+/-1%) official target.Source: JPMorgan and IMF.

18SE

AR

CH

IN

GF

OR

AR

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IO

NA

LE

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Latam inflation.ppt

-2

-1

0

1

2

3

4

Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

9

11

13

15

17

19

21

Headline deviation from target

Core deviation from target

Policy rate

Brazil: Headline and core inflation deviation from target and policy rate (%)Brazil: Headline and core inflation deviation from target and policy rate (%)

Source: IBGE and BCB

Central banks policy rates seem to respond more to headline than core inflation

19SE

AR

CH

IN

GF

OR

AR

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NA

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Latam inflation.ppt

-0.5

0

0.5

1

1.5

2

2.5

3

Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

3

4

5

6

7

8

9

10

11

Headline deviation from target

Core deviation from target

Policy rate

Mexico: Headline and core inflation deviation from target and policy rate (%)Mexico: Headline and core inflation deviation from target and policy rate (%)

Source:Banxico

In Mexico shocks have resulted in both headline and core components

20SE

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Agenda

Page

B C R P - W O R L D B A N K S E M I N A R , L I M A , P E R U , 1 6 - 1 7 J U N E , 2 0 0 8

Latam inflation.ppt

A final comment

Investigating Mexico’s reaction function

Searching for a rationale of external shocks

Surprises on inflation and growth

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Latam inflation.ppt

-0.10

0.00

0.10

0.20

0.30

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

Source: JPMorgan

Source: JPMorgan Source: JPMorgan

Source: JPMorgan

Impulse response of policy rate Impulse response of policy rate Impulse response from 1 year inflation expectations shock Impulse response from 1 year inflation expectations shock

Impulse response from a 4 years inflation expectations shockImpulse response from a 4 years inflation expectations shock Impulse response from monthly headline CPI %oya shockImpulse response from monthly headline CPI %oya shock

Banxico impulse responses of policy rate

-0.10

0.00

0.10

0.20

0.30

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

-0.10

0.00

0.10

0.20

0.30

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

-0.10

0.00

0.10

0.20

0.30

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

22IN

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Latam inflation.ppt

-0.10

0.00

0.10

0.20

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

Source: JPMorgan

Source: JPMorgan Source: JPMorgan

Source: JPMorgan

Impulse response from economic activity shockImpulse response from economic activity shock

Impulse response from real exchange rate shockImpulse response from real exchange rate shock

Impulse response from Fed Fund rate shockImpulse response from Fed Fund rate shock

Impulse response from monthly core CPI %oya shockImpulse response from monthly core CPI %oya shock

Banxico impulse responses of policy rate

-0.20

-0.10

0.00

0.10

0.20

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

-0.20

-0.10

0.00

0.10

0.20

0.30

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

-0.20

-0.10

0.00

0.10

0.20

1 2 3 4 5 6 7 8 9 10

+/-2 standard deviations

Months after initial shock

%pts change

23IN

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Latam inflation.ppt

Variance decomposition (% unless indicated)Variance decomposition (% unless indicated)

1. Deviation from Banxico’s 3% mid-point target.2. Deviation from 3.5% potential growth rate3. Deviation in % points from 5-years average. Source: JPMorgan

Variance decomposition

Months after the initial shock

1 2 3 4 5 6 7 8 9 10

Policy rate 100 65 51 41 34 29 25 23 21 19

1yr inflation expectations1 0 9 25 34 39 42 42 42 41 39

4yr inflation expectations1 0 3 3 6 10 12 13 13 13 12

Headline CPI (%oya)1 0 0 2 2 3 5 7 9 10 10

Core CPI (%oya)1 0 1 1 1 2 2 2 2 3 3

Economic Activity (%oya)2 0 10 7 5 4 3 3 3 2 3

Real exchange rate3 0 5 4 3 3 3 4 5 8 11

Fed Fund rate 0 7 8 7 6 5 4 4 3 3

Total Variance 100 100 100 100 100 100 100 100 100 100

24IN

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Latam inflation.ppt

3.4

3.6

3.8

4.0

4.2

4.4

Jan-07 Apr-07 Jul-07 Oct-07 Dec-07 Mar-08 Jun-08

6.9

7.0

7.1

7.2

7.3

7.4

7.5

7.6

5 year breakeven inflation

Banxico Policy rate

Source: JPMorgan and Banxico Source: Banxico survey

Mexico breakeven inflation (%)Mexico breakeven inflation (%) Banxico policy rate and inflation expectations Banxico policy rate and inflation expectations

Banxico’s response seems geared to inflation expectations

3.3

3.5

3.7

3.9

4.1

4.3

4.5

Jan-04 Aug-04 Apr-05 Nov-05 Jul-06 Mar-07 Oct-07 Jun-08

5

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10

One year forward

Four years forward

Banxico Policy rate

%oya bp

25IN

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Latam inflation.ppt

Source: Labor Ministry and Banxico Source: Labor Ministry and Banxico

Nominal wage increases in negotiations and Banxico’s policy rate

Nominal wage increases in negotiations and Banxico’s policy rate

Nominal wage increases in private sector and Banxico’s policy rate

Nominal wage increases in private sector and Banxico’s policy rate

However, the central bank typically responds ahead of inflation contamination in labor markets

3.5

3.7

3.9

4.1

4.3

4.5

4.7

4.9

5.1

Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08

6.8

7

7.2

7.4

7.6

7.8

8

Wages negotiations

Banxico Policy rate

%oya bp

3.8

4

4.2

4.4

4.6

4.8

5

5.2

5.4

Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Feb-08 Jun-08

6.8

7

7.2

7.4

7.6

7.8

8

Wages negotiations in private sector

Banxico Policy rate

%oya bp

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Agenda

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Latam inflation.ppt

A final comment

Investigating Mexico’s reaction function

Searching for a rationale of external shocks

Surprises on inflation and growth

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Latam inflation.ppt

Investment to GDP (%) Growth rate of real GDP per worker

1950-59 1970-79 2000-04 1950-59 1970-79 2000-04

Argentina 15.73 20.72 12.19 1.05 1.32 -4.61

Brazil 25.43 26.19 14.73 4.30 4.25 -0.02

Chile 31.04 15.64 20.88 1.46 -0.50 1.10

Colombia 15.99 13.95 9.51 2.33 2.62 -0.70

Mexico 19.22 21.49 19.03 3.79 2.26 -1.72

Peru 41.74 16.15 15.69 2.17 -0.01 -0.08

Venezuela 40.00 30.51 11.23 4.42 0.44 -6.06

Latin America: Investment to GDP and growth rate per worker (%)Latin America: Investment to GDP and growth rate per worker (%)

Source: University of Pennsylvania, Center for International Comparisons of Production, Income and Prices

Why do Latin central banks respond to headline and not core as the US Fed does?

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Latam inflation.ppt

Investment to GDP (%) Growth rate of real GDP per worker

1950-59 1970-79 2000-04 1950-59 1970-79 2000-04

China 22.82 28.29 29.99 4.76 3.53 7.39

Indonesia 8.42 11.66 11.50 1.98 1.24 3.68

Korea 11.71 27.25 34.53 2.34 5.79 3.33

South Africa 11.35 13.07 7.96 2.24 1.19 2.31

Taiwan 9.20 20.46 17.00 5.60 7.21 …

Thailand 15.56 30.57 21.29 -0.75 3.99 3.92

Asia: Investment to GDP and growth rate per worker (%)Asia: Investment to GDP and growth rate per worker (%)

Source: University of Pennsylvania, Center for International Comparisons of Production, Income and Prices

Limited productivity growth seems the answer

Latin America: Investment to GDP and growth rate per worker (%)Latin America: Investment to GDP and growth rate per worker (%)

Investment to GDP (%) Growth rate of real GDP per worker

1950-59 1970-79 2000-04 1950-59 1970-79 2000-04

Argentina 15.73 20.72 12.19 1.05 1.32 -4.61

Brazil 25.43 26.19 14.73 4.30 4.25 -0.02

Chile 31.04 15.64 20.88 1.46 -0.50 1.10

Colombia 15.99 13.95 9.51 2.33 2.62 -0.70

Mexico 19.22 21.49 19.03 3.79 2.26 -1.72

Peru 41.74 16.15 15.69 2.17 -0.01 -0.08

Venezuela 40.00 30.51 11.23 4.42 0.44 -6.06 Source: University of Pennsylvania, Center for International Comparisons of Production, Income and Prices

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Latam inflation.ppt

0

1

2

3

4

5

6

7

8

9

1999 2000 2001 2002 2003 2004 2005 2006 2007

Mexico

US

Avg 2000-03=3.3% per year

Avg: 2000-03=5.7% per year

Avg 2000-03=2.7% per year

Avg: 2000-03=4.1% per year

%oya, 1yr ma

Source:INEGI Source: INEGI

Mexico and US: Labor productivity in manufacturingMexico and US: Labor productivity in manufacturing Mexico and US: Unit labor costs in manufacturingMexico and US: Unit labor costs in manufacturing

Mexico is a good experience

-10

-5

0

5

10

15

20

1999 2000 2001 2002 2003 2004 2005 2006 2007

Mexico

US

Avg: 2005-07=1.7% per year

Avg: 2005-07=-1.9% per year

% oya, 1-yr ma

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J U N E 2 0 0 8

L A T I N A M E R I C A ´ S I N F L A T I O N

Alfredo Thorne, MD, Global Economics Department

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