Last week, the Colombian Central Bank cut its benchmark rate by 50 points to 3.5%, as the local economy continues to struggle and the fall in inflation gives the Central Bank room to keep expanding its monetary policy in order to both stimulate the demand for goods and services of Colombian households and prevent further deterioration in the local FX market. However, the Central Bank may have made one major mistake, using monetary tools to tackle a mild recession and the foreign exchange rate.
One of the major arguments in support of the current monetary policy is that Colombia is facing a recession and therefore monetary tools are needed to stimulate the demand for goods and services. The validity of this argument is undeniable as long as it does not overshoot the long term targets of the policy itself, which seems to be the case nowadays for two major reasons.
The first is that the Banco de la República is pursuing an ambivalent long term monetary policy. The Colombian Central Bank is using monetary tools in response to an event that is currently happening, instead trying of preventing the event from ever happening, as should be its goal. That kind of reactive policy is quite permissive, as once the factors that triggered the current expansionary policy change, it will compel the policy makers to react by raising rates rapidly in order to adjust the excess of liquidity.
Colombia has gone through various examples of this kind of reactive policy. As of the third quarter of 2008, the Colombian Central Bank pursued a tightening monetary policy, increasing the benchmark rate by 500 points to 10% in a two year period. Although there were crystal clear signs that the United States was facing a difficult economic period and the local economic data was showing signs of distress, the Banco de la República kept raising rates until the recession had already gained a foothold on the economy.
So they began to act, pushing the benchmark rate aggressively down to 8% in just two meetings in order to show the Central Bank's decisiveness in heading off any possible recession. Nonetheless, Colombia at that time was already in recession, as was shown by the Colombian Statistic Department GDP data later on.
The second reason is that policy makers are not letting the effects of the rate cuts to get a foothold on the economy, in what is known as “the laggard effect.” This laggard effect, the time monetary policy takes to flow into the economy, takes over 12 months in the Colombian case. So policy makers are acting according to the flow of data, which will prove to be a huge mistake as the economy has not assimilated the effects of the rate cuts, leading to long-term distortions of the economy.
At first look, it seems the Central Bank has not taken any notice of this laggard effect, as its rate-cuts-madness has not finished. So far, it has taken down the benchmark rate by 650 basis points to 3.5% in just 12 months.
The third is the impact of the current crisis with Venezuela and its effects on the supply side. This is an equation with two sides. On one hand, the low inflation in Colombia has been a result of a fall in food prices caused by the supply-side, as the Venezuelan market has been closed to Colombia imports; hence, food producers have flooded the local markets with their goods pushing down food prices and consequently lowering overall inflation. On the other hand, the fall of Colombian industrial production has also been a consequence of the crisis with Venezuela as this market has been closed for Colombian manufactured goods. This reminds us that Venezuela was Colombia's biggest market.
So this proves that monetary policy has not had any effect on inflation as it has been dragged by external factors pushing the supply side of the equation, and also proves that it is unlikely that cutting rates will create new markets for Colombian manufacturing goods, which is what is required for the long-term sustainability of the economy.
Next week, part two: monetary policy tackling Colombian exchange rates
Author Luis J. Rodríguez is CEO of e-Bursatil.com.co, a website focused on Colombia's financial market
gringomedellin
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... The Colombian Central Bank is using monetary tools in response to an event that is currently happening, instead trying of preventing the event from ever happening, as should be its goal. While this is a noble goal, Colombia is forced to deal with issue that happened outside of it's control, the recession hit deeply in North America, Europe and Asia , which lead to a mild recession in Colombia, if the central bank failed to react to actions of others it clearly would lead to a deep recession. what they might feel to understand most experts say a rate change takes about 6 months to fully affect the economy or maybe the US central bank got it wrong with baby steps down to where it was to late a deep recession took hold and Colombia's aggessive move was a smarter one . This reminds us that Venezuela was Colombia's biggest market. My understand is that the USA is the biggest trade partner with Colombia, Venzuela second , but in recent months has dropped to number 3 , i think it was China that moved into number 2, but I not 100%, if that is the case clearly a more stable trade partner then Venezuela. |
