Monetary policy in Colombia is witnessing an unprecedented tightening, the central bank has raised the key interest rate from 1.75 percent in September 2021 to 12.75 percent in January this year.
The shocks to inflation since 2021 have led to challenges to the public disclosure process by the central bank. The large and prolonged inflationary impact of such shocks requires a long period of convergence towards the inflation target to be explained to the public. Getting too close to the target too quickly can be costly for output and employment, but getting too close over too long threatens to derail inflationary expectations.
The central bank finally announced that the monetary tightening process is not over yet, and expressed its commitment to reduce inflation and bring it to the target level of 3% over two years with an acceptable deviation of one percentage point. Fortunately, inflationary expectations are generally in line with the desired convergence path. Inflation targeting has helped Colombia to cope with economic shocks in a way that was not possible before.
Inflation is expected to fall rapidly by historical standards, but it will most likely remain above its target rate for the longest period since the introduction of the inflation targeting system. This will make it even more difficult to maintain the credibility of this goal as the nominal pillar of the economy.
There is no doubt that the challenges to monetary policy will be difficult, especially during 2023 and 2024. We expect a sharp slowdown in economic activity that will lead to a contraction in GDP growth to a small percentage of no more than 0.2 percent in 2023 as a result of further tightening of global financial conditions, slowing growth in our trading partner countries, and restrictive domestic monetary policy, which is clearly urgently needed and ensures that inflation approaches the achievement of the central bank’s target.
These challenges do not represent an argument against the merits of the inflation targeting strategy. Rather, it reinforces the importance we attach to strengthening the role of this strategy as a pillar of the economy and to the need to work at the current juncture to implement a restrictive monetary policy that demonstrates the extent to which the central bank is committed to an explicit and reliable inflation target.
The inflation targeting system coupled with the exchange rate has greatly benefited Colombia’s economy, helping the country to cope with economic shocks in a way that was not possible before. We believe that strengthening its credibility remains the best way to overcome these difficult circumstances.
