Since 2000, Colombia has operated under an inflation targeting scheme as the framework for its monetary policy. with an explicit goal of 3% that has allowed the expectations of households and companies to be guided.
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During this period, the country managed to significantly reduce the high levels of inflation that characterized previous decades, contributing to a more predictable environment for economic decision-making. However, after an analysis carried out by the Sectorial firm, the need to review and update this monetary policy framework arises in the face of an increasingly complex and challenging economic environment.
The inflation targeting scheme has strengthened the reputation of the Bank of the Republic as a technical and autonomous entity, improving economic predictability both at the corporate level and in the public sector. The interest rate, adjusted by the monetary authority, has been the main tool to achieve this objective for two and a half decades.
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Nevertheless, “the current economic environment presents conditions that did not exist when the scheme was implemented; and events such as the pandemic, the fragmentation of global supply chains and the effects of climate change have made supply shocks more frequent, which affect prices without necessarily responding to variations in demand”says Alejandro Escobar, strategic manager of Sectorial.
In his opinion, taking into account the current context, modifying interest rates is not always effective in controlling inflation and can generate adverse effects on economic growth or employment. Supply shocks, climate risks and social changes limit the effectiveness of traditional tools.
The strategic manager of Sectorial proposes to review the current framework without abandoning the central objective of price stability, through two strategies:
1. Expand the goal to a range: One of the most frequent proposals is to replace the specific goal of 3% with a range, for example, from 2% to 4%. This would allow greater flexibility in the face of temporary shocks and could reduce the need to apply restrictive measures that affect economic activity.
2. Include complementary objectives: It also suggests considering additional variables such as employment or financial stability in the analysis of monetary policy. Countries like the United States already operate with dual mandates that include employment stability along with inflation control.
“The update of the scheme should not be interpreted as a criticism of its performance. On the contrary, the scheme has been effective in fulfilling its original purpose. The point is that the context has changed, and it is worth reviewing whether the current framework is still the most appropriate for the challenges of the present and the future,” says the Sectorial expert.
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For Escobar, adopting a broader target range and considering other variables in the analysis would allow the Banco de la República to make more balanced decisions and maintain a greater capacity to respond to current economic challenges.
“It is about maintaining price stability as a central objective, but with tools that respond better to current conditions”he concludes.
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