Exchange Rate Anchor (USD): In this regime, the monetary authority buys or sells currencies (US dollars or USD) to maintain the exchange rate at a predetermined level or within a range. Thus, the exchange rate serves as a nominal anchor or intermediate target for monetary policy.

Monetary Aggregate Targeting: The intermediate monetary policy target is one of the monetary aggregates, although the country may also set inflation targets. The central bank can use an amount (central bank reserves or base currency) or a price variable (policy rate) as an operational target.

Inflation Targeting: This regime implies the public announcement of numerical inflation targets, with a commitment by the monetary authority to achieve them, generally in a medium-term horizon. Monetary policy decisions are usually determined by the deviations of inflation expectations from the announced inflation target. Thus, inflation expectations act (implicitly or explicitly) as the intermediate target of monetary policy.

Other: Includes countries that have not explicitly established a nominal anchor, but monitor various indicators in the conduct of monetary policy.

Argentina: Annualized nominal monetary policy rate, corresponding to the lower limit of the LELIQ interest rate (7-day liquidity letters).
Sources: Haver Analytics, with data from The National Institute of Statistics and Censuses (INDEC) for inflation, Central Bank of the Argentine Republic for interest rates.

Aruba: Central Bank Lending Rate, is the discount rate of the central bank.
Sources: Centrale Bank van Aruba.

The Bahamas: Discount (Bank) Rate, is the central bank's discount rate.
Sources: Central Bank of The Bahamas.

Barbados: Treasury Bill Rate, Interest rate on Barbados' treasury certificates reported to the IMF.
Sources: Central Bank of Barbados for inflation. International Financial Statistics (IMF) for interest rate.

Belize: T-Bills Yields (May-21), Treasury bills are discounted securities issued and guaranteed by the Government of Belize with a maturity period of less than one year at a variable interest rate.
Sources: Haver Analytics with data from the Statistical Institute of Belize for inflation. Central Bank of Belize for the interest rate.

Bolivia: Reference Rate (TRe) for May 2021 in local currency This rate is calculated monthly with data from commercial banks' balance sheets, reflects the banks' real financial cost, and is the prime rate for variable rate loans.
Sources: Haver Analytics with data from the National Institute of Statistics for inflation. Central Bank of Bolivia for the interest rate.

Brazil: Selic. This rate refers to the interest rate calculated on overnight loan transactions between financial institutions using federal government securities as collateral.
Sources: Haver Analytics with data from the Brazilian Institute of Geography and Statistics for inflation. Central Bank of Brazil for the interest rate.

Chile: The Monetary Policy Rate (MPR) is the rate that determines the level of the interbank overnight lending rate, achieved through open market operations.
Sources: Haver Analytics with data from the National Institute of Statistics for inflation. Central Bank of Chile for the interest rate.

Colombia: The monetary policy intervention rate is the minimum interest rate that the Banco de la República charges to financial entities for the loans it makes to them through open market operations.
Sources: Haver Analytics with data from the National Administrative Department of Statistics for inflation. Banco de la República for the interest rate.

Costa Rica: The Monetary Policy Rate (MPR), is the interest rate charged by the BCCR on its overnight credit operations (loans) in the Interbank Money Market.
Sources: Haver Analytics with data from the National Institute of Statistics and Censuses of Costa Rica for inflation. Central Bank of Costa Rica for the interest rate.

Cuba: Reference Interest Rates for the Banking System - CUC Liability Rate at sight, is the yield charged by the customer of a financial institution to maintain their accounts in the financial system. The inflation data corresponds to the UNCTAD estimate.
Sources: Central Bank of Cuba for the interest rate, and UNCTAD for inflation.

Curaçao and Sint Maarten: Official (Legal) Interest Rates (January 1 - June 30, 2021).
Sources: Central Bureau of Statistics of Curaçao for inflation. Centrale Bank of Curaçao and Sint Maarten for interest rate.

ECCU: ECCB Discount Rate.
Source: ECCB.

Ecuador: The Central Bank of Ecuador's Basic Rate is the weighted average nominal yield of securities with a term of less than one year, issued and placed by the Central Bank of Ecuador in the 4 weeks prior to the week of publication.
Sources: Haver Analytics with data from the National Institute of Statistics and Censuses for inflation. Central Bank of Ecuador for the interest rate.

El Salvador: Repo Rate (1-7 days term) from April 30, 2021.
Sources: Haver Analytics with data from the Central Reserve Bank of El Salvador for inflation. Central Reserve Bank of El Salvador for the interest rate.

Guatemala: Leading Interest Rate. This is the interest rate for the placement of term deposits applied by the Banco de Guatemala in its 1-day monetary stabilization operations.
Sources: Haver Analytics with data from the National Institute of Statistics for inflation. Bank of Guatemala for the interest rate.

Guyana: Bank Rate is the central bank's discount rate.
Sources: Bureau of Statistics for inflation. Bank of Guyana for the interest rate.

Haiti: The Mise in pension is the central bank's repo rate.
Sources: Haitian Institute of Statistics and Information Technology for Inflation. Banque de la République d'Haïti for the interest rate.

Honduras: The Monetary Policy Rate (MPR) will be the maximum rate accepted for purchase bids in liquidity auctions directed to the institutions of the national financial system, and will be the minimum for sale bids, serving as a reference for interbank operations.
Sources: Haver Analytics with data from the Central Bank of Honduras for inflation. Central Bank of Honduras for the interest rate.

Cayman Islands:
Source: Economics and Statistics Office for inflation.

Jamaica: The Policy Interest Rate is the overnight funding interest rate paid by the Bank of Jamaica.
Sources: Haver Analytics with data from the Statistics Institute of Jamaica for inflation. Bank of Jamaica for the interest rate.

Mexico: The Target Rate is the goal established by the Bank of Mexico for the interest rate on overnight interbank funding operations.
Sources: Haver Analytics with data from the National Institute of Statistics and Geography for inflation. Bank of Mexico for the interest rate.

Nicaragua: Weighted 1-month liability rates in local currency.
Sources: Haver Analytics with data from the National Institute of Information for Development for inflation. Central Bank of Nicaragua for the interest rate.

Paraguay: The Monetary Policy Target Rate is the target interest rate for overnight interbank loans.
Sources: Haver Analytics with data from the Central Bank of Paraguay for inflation. Central Bank of Paraguay for the interest rate.

Peru: The Reference Interest Rate is the one that establishes a reference level for the interbank market interest rate.
Sources: Haver Analytics with data from the National Institute of Statistics and Information for inflation. Central Reserve Bank of Peru for the interest rate.

Dominican Republic: The Monetary Policy Rate is an indicative rate which defines the rates of the permanent facilities of monetary contraction and expansion at a 1-day term with the purpose of influencing the inter-bank interest rates.
Sources: Haver Analytics with data from the Central Bank of the Dominican Republic for inflation. Central Bank of the Dominican Republic for the interest rate.

Suriname: The Average Interbank Rate is the monthly average of the interbank interest rate. The data corresponds to March 2021.
Sources: Haver Analytics with data from the Centrale Bank van Suriname for inflation. Centrale Bank van Suriname for the interest rate.

Trinidad and Tobago: The Repo Rate is the central bank's repo rate.
Sources: Haver Analytics with data from the Central Bank of Trinidad and Tobago for inflation. Central Bank of Trinidad and Tobago for the interest rate.

Uruguay: The Monetary Policy rate corresponds to the reference rate for overnight placements.
Sources: Haver Analytics with data from the National Institute of Statistics for inflation. Central Bank of Uruguay for the interest rate.

Venezuela: The Passive Term Deposit Rate is the weighted average nominal annual passive interest rate for term deposits of less than 30 days.
Sources: Haver Analytics with data from the Central Bank of Venezuela for inflation. Banco Central de Venezuela for the interest rate.

No separate legal tender: This classification implies a de jure exchange rate in which the currency of another country circulates as the only legal tender.

Currency board: This classification implies a de jure exchange rate in which there is an explicit legislative commitment to exchange national currency for a specific foreign currency at a fixed exchange rate.

Conventional peg: In this category, the country formally sets its de jure exchange rate at a fixed rate against another currency or a basket of currencies. The weights of the anchor currency or basket are public or are notified to the IMF. The country's authorities are willing to maintain the fixed parity through direct intervention.

Stabilized arrangement: This classification implies an exchange rate in the spot market that remains within a 2% margin for six months or more and is not floating.

Crawling peg: In this category the de jure exchange rate is adjusted in small amounts, at a fixed rate, or in response to changes in selected quantitative indicators; for example, based on the differentials between the inflation target and expected inflation in major trading partners. The rules and parameters of the arrangement are either public or notified to the IMF.

Crawl-like arrangement: In this classification, the exchange rate must remain within a 2% margin in relation to a statistically identified trend for six months or more and where the exchange rate cannot be considered as floating.

Other managed arrangement: This category is used when the exchange rate regime does not meet the criteria of any of the above categories.

Floating: A floating exchange rate is largely determined by the market, and has no particular or predictable trajectory. Intervention in the exchange market can be direct or indirect, and such intervention serves to avoid undue fluctuations in the exchange rate, but only if these policies do not aim at a specific level. Floating regimes can exhibit some volatility, depending on the magnitude of the shocks affecting the economy.

Free floating: A floating exchange rate can be classified as free floating if the interventions occur only in exceptional cases and are intended to correct disorderly exchange market conditions and if the authorities provide information confirming that the interventions have occurred in a maximum of three instances in the previous six months, where each intervention lasted no more than three working days.

Argentina:

Source: National Institute of Statistics and Censuses (INDEC).

Aruba:

Source: Centrale Bank van Aruba.

Bahamas:

Source: Department of Statistics - Government of the Bahamas.

Barbados:

Source: World Bank Open Data.

Belize:

Source: Statistical Institute of Belize.

Bolivia:

Source: National Institute of Statistics.

Brazil:

Source: Brazilian Institute of Geography and Statistics

Chile:

Source: Central Bank of Chile.

Colombia:

Source: National Administrative Department of Statistics.

Costa Rica:

Source: Central Bank of Costa Rica.

Cuba:

Source: World Bank Open Data.

Curaçao and Sint Maarten:

Source: World Bank Open Data.

ECCU:

Source: ECCB.

Ecuador:

Source: Growth estimated using the quarterly seasonally adjusted GDP series. Source: Central Bank of Ecuador.

El Salvador:

Source: Central Reserve Bank of El Salvador.

Guatemala:

Source: Bank of Guatemala.

Guyana:

Source: World Bank Open Data.

Haiti:

Source: World Bank.

Honduras:

Source: Central Bank of Honduras.

Cayman Islands:

Source: Economics and Statistics Office.

Jamaica:

Source: Statistics Institute of Jamaica.

Mexico: Note: Preliminary growth datum.


Source: National Institute of Statistics and Geography (INEGI).

Nicaragua:

Source: Central Bank of Nicaragua.

Paraguay:

Source: Central Bank of Paraguay.

Peru:

Source: National Institute of Statistics and Information Technology.

Dominican Republic:

Source: Central Bank of the Dominican Republic.

Suriname:

Source: Centrale Bank van Suriname.

Trinidad and Tobago:

Source: Central Bank of Trinidad and Tobago.

Uruguay:

Source: Central Bank of Uruguay.

Venezuela:

Source: Central Bank of Venezuela.

Brazil: Notes: Monthly averages of the midpoint of the sale rate and the purchase rate of each instrument.
Source: Tesouro Direto .

Chile: Notes: The interest rates correspond to the "Benchmark in pesos" of 5 and 10 years. These are the weighted average by amount of interest rates of Central Bank and Treasury bonds issued in the primary market, and of bonds traded in the Santiago Stock Exchange (Statistical Bulletin - August 18, 2020).
Source: Central Bank of Chile.

Colombia: Notes: Average monthly rates. Zero coupon rates are calculated from information on market prices of TES in pesos, using Nelson & Siegel's model. For this calculation, the information of the operations negotiated and registered in the negotiation systems administered by Banco de la República and Bolsa de Valores de Colombia is used.
Source: Banco de la República.

Costa Rica: Notes: Sovereign yield curve rates in effect for the period indicated in the table. Rates net of taxes.
Source: Central Bank of Costa Rica.

Mexico: Notes: Fixed-rate bonds with maturities of 5-, 10- and 20-years. Rates net of taxes.
Source: Bank of Mexico.

Peru: Notes: 5- and 20-year rates recorded in the daily report of the date indicated in the table.
Source: Ministry of Economy and Finance.

Argentina: Current Account Balance as a % of GDP; Gross Public debt as % of annualized GDP; Public Sector: Budget Balance as a % of GDP.

Source: Haver Analytics.

Aruba: Current Account; Total Outstanding Government Debt; Financial Deficit. We estimate each of these series as a proportion of GDP. Data from Central Bank of Aruba.

The Bahamas: Current Account, Central Government Debt Total Direct Charge, Financial Surplus (Deficit). We estimate these series as a proportion of GDP based on data from the Department of Statistics.

Source: Central Bank of the Bahamas.

Barbados: Current Account Balance, % of GDP. Source: Central Bank of Barbados. Gross Public Sector Debt as a % of GDP. Source: Central Bank of Barbados. Fiscal Deficit/Surplus as a % of GDP.

Source: Central Bank of Barbados.

Belize: Current Account and Overall Balance. We estimate these series as a % of GDP by converting the local currency series to USD at the average exchange rate for the period, using data from Haver Analytics.

Source: Central Bank of Belize. Central Government Debt as a % of GDP. Source: IMF Global Debt Database.

Bolivia: Current Account Balance as a % of GDP. Source: Haver Analytics. Central Government Debt as a % of GDP.

Source: IMF Global Debt Database. Surplus (Deficit) Global (Fiscal). We estimate these series as a % of GDP based on data from Haver Analytics. Source: Banco Central de Bolivia.

Brazil: Current Account Balance as a % of GDP; Total Federal Public Debt as % of Annualized GDP, published by the Central Bank of Brazil monthly with the monthly estimate of GDP; National Treasury Performance Summary Surplus/Deficit.

Source: Haver Analytics.

Chile: Current Account Balance Current Account Balance as a % of GDP; Central Government: Surplus/Deficit as % of GDP.

Source: Haver Analytics. Central Government Gross Debt. We estimate the Debt series as a % of GDP. Source: Haver Analytics: based on data from the Central Bank of Chile.

Colombia: Current Account Balance Current Account Balance as a % of GDP; Central Government Gross Debt as % of annualized GDP; Central Government Surplus/Deficit as % of GDP.

Source: Haver Analytics.

Costa Rica: Current Account Balance as a % of GDP. Source: Haver Analytics. Central Government, Debt Balance.

Source: Haver Analytics: Ministry of Finance. Central Government Financial result as % of GDP. We estimate the Debt series as a % of GDP.

Source: Ministry of Finance.

Curaçao and Sint Maarten: Current Account as a % of GDP (Curaçao).

Source: Central Bureau of Statistics and the Central Bank of Curaçao and Sint Maarten.

ECCU: Current Account Balance; Public Sector Debt over GDP; Overall Balance. We estimate the Current Account and Debt series as a % of GDP.

Source: ECCU: based on data from ECCB Central Bank.

Ecuador: Current Account Balance as a % of GDP; Central Government Gross Debt as % of annualized GDP, seasonally adjusted; Central Government Budget Surplus/Deficit as a % of GDP.

Source: Haver Analytics.

El Salvador: Current Account Balance as a % of GDP; Government Debt as a % of annualized GDP.

Source: Haver Analytics. Surplus or Deficit including donations. We estimate the Fiscal Surplus series as a proportion of GDP using data from Haver Analytics. Source: Haver Analytics: based on data from the Central Reserve Bank of El Salvador.

Guatemala: Current Account Balance as a % of GDP; Central Government Budget Surplus/Deficit as a % of GDP.

Source: Haver Analytics. Government Debt. We estimate the Debt series as a % of GDP using data from Haver Analytics. Source: Banco de Guatemala.

Guyana: Current Account; Total Public Debt Stock; Overall Balance After Grants.

Source: Bank of Guyana.

Haiti: Current Account. We estimate the Current Account series as a % of GDP by converting the GDP series in local currency to USD at the average exchange rate for the period using data from Haver Analytics. Source: Bank of the Republic of Haiti. Central Government Debt as a % of GDP.

Source: IMF Global Debt Database. Net Lending/Borrowing (Overall Balance). Source: IMF Fiscal Monitor.

Honduras: Central Government Debt as a % of GDP. Source: IMF Global Debt Database. Central Government Budget Balance as % of GDP.

Source: Haver Analytics.

Cayman Islands: Current Account; Central Government Debt and Self-Financing Debt; Net lending/Net Borrowing. We estimate each of these series as a % of GDP.

Source: Economics and Statistics Office.

Jamaica: Current Account Balance as a % of GDP; Central government debt as a % of Annualized GDP; Fiscal Balance. We estimate the surplus/deficit series as a proportion of GDP.

Source: Haver Analytics.

Mexico: Current Account Balance as a % of GDP; Federal Government Gross debt as a % of GDP; Public Sector Budgetary Surplus/Deficit as % of NSA GDP.

Source: Haver Analytics.

Nicaragua: Current Account Balance as a % of GDP.

Source: Haver Analytics. Central Government Internal and External Debt Balance; Central Government Balance, net operating result. We estimate the series of Debt and Surplus/Deficit as a % of GDP. Data from the Central Bank of Nicaragua.

Paraguay: Current Account Balance as a % of GDP; Central Government Budget Surplus/Deficit as a % of GDP.

Source: Haver Analytics. Public Debt, General Government Debt. We estimate the series of Debt as a proportion of GDP with data from Haver Analytics. Source: Haver Analytics: Ministry of Finance.

Peru: Current Account Balance as a % of GDP; Federal Government Gross debt as a % of annualized GDP; Government Budget Surplus/Deficit as a % of GDP.

Source: Haver Analytics.

Dominican Republic: Current Account Balance as a % of GDP; Central Government: Surplus/Deficit as % of GDP.

Source: Haver Analytics. Balance of Central Government Obligations. We estimate the series of Debt as a % of GDP using data from Haver Analytics. Source: Haver Analytics: General Directorate of Public Credit.

Suriname: Current Account.

Source: Centrale Bank van Suriname. Total Debt according to the Act in millions of SRD (cash), General Government Debt. Source: Bureau voor de Staatsschuld. Financial Deficit. Source: Bureau voor de Staatsschuld: Ministry of Finance. We estimate each of these series as a % of GDP using data from the Centrale Bank van Suriname.

Trinidad and Tobago: Current account; Central government total debt to GDP; Overall fiscal balance as percent of GDP.

Source:Central Bank of Trinidad and Tobago.

Uruguay: Current Account Balance as a % of GDP; Public Sector Budgetary Surplus/Deficit as % of GDP.

Source: Haver Analytics. Central Government Gross Debt. We estimate the series of Debt as a % of GDP with data from the Central Bank of Uruguay. Source: Haver Analytics: Debt Management Unit.

Venezuela: Current Account Balance, % of GDP.

Source: IMF World Economic Outlook. Gross Debt Position as % GDP; Net Lending/Borrowing (also referred as overall balance). Source: IMF Fiscal Monitor.

The estimation of the term premium requires an econometric model. In this case, the methodology and model proposed by Adrian, Crump, and Moench (2013, ACM) was chosen. This is due to the following reasons:

It is a relatively recent and accepted methodology. In this context, estimations for U.S. data are published periodically by the Federal Reserve Bank of New York on its website. This allows a direct comparison with the time series for the U.S. economy.

The estimation methodology is fast, which allows a periodic update.

It is generally a robust methodology, particularly in the case of emerging economies such as those of the region..

That said, it is convenient to underline the following caveats. The estimation of the term premium depends on both the model and the economic variables used as inputs. In this case, an affine model of interest rates is used with interest rates at different terms as inputs. The estimate is also a function of the sample used. This is derived from the fact that interest rates are usually persistent stochastic processes.

The level of the term premium is one of the statistics that are most sensitive to the choice of model, inputs, and sample used. The consideration of these caveats is especially relevant when comparing different estimates of the term premium, including those shown here. However, the dynamics of the term premium are more robust to the above-mentioned variants. Analytically, we have the following expression:

Unless rates are used in continuous compounding, a linear approximation may be inaccurate. In addition, zero coupon interest rates need to be used, particularly for emerging economies.

We estimate term premiums for Brazil, Chile, Colombia, Mexico and Peru associated with 10-year interest rates. This selection depends on the availability of data and the existence of long-term bond markets. We use simple rates.

Monetary and fiscal policies are two of the main tools for pursuing and achieving macroeconomic stability. Coordination between such policies is relevant as both can have an impact on two of the most important relative prices in an economy: the real interest rate and the real exchange rate. The magnitude and temporality of such an impact depend on several factors: the level of inflation, the deviation of inflation from the central bank's target, the nature of financial frictions, the credibility of the monetary and fiscal authorities, the level of government debt, the dynamics of the fiscal deficit and the balance of external accounts, among others.

The government has to satisfy its inter-temporal budget restriction. In particular, in each period, expenditures minus revenues equals the deficit. Part of these revenues could come from the inflation tax. Thus, if the government cannot access financial markets to issue more debt, a rise in the inflation tax would decrease the real value of the nominal debt (denominated in local currency), thus, satisfying the budget constraint. This would subordinate monetary policy to fiscal policy (fiscal dominance).

The choice of which policy to use to address macroeconomic and/or financial shocks, or in some cases which combination of these, depends on their nature. 1/ Thus, it is essential to have both policies prepared within the toolbox of economic policy makers. A necessary condition for this to happen is the absence of fiscal dominance (Sargent and Wallace, 1981). In recent history, particularly in the 1980s and 1990s, several Latin American economies faced situations of fiscal dominance (e.g., Esquivel, C. et al. 2019).

^1/ However, the real value of foreign debt is not affected by inflationary shocks. In general, in order to service foreign debt, it is necessary to generate surpluses in the external accounts. To this end, the real exchange rate tends to depreciate, which in turn tends to increase exports and reduce imports. To the extent that the depreciation of the real exchange rate is a market phenomenon, reflecting an adjustment in the relative prices of the economy, this should not have a significant impact on inflation. Nonetheless, if monetary policy is used to try to generate a continuous depreciation of the nominal exchange rate (and therefore of the real exchange rate), this would result in a sustained increase in prices and inflation. Obviously, the risk is that it would initiate an inflationary spiral from the exchange rate to prices to the exchange rate. In this case, the inflationary tax would be operating on holders of debt denominated in local currency, and the resources collected would be directed to serve the foreign currency debt. Of course, this brings a redistribution of resources, from the holders of domestic debt to those of foreign debt. For all the above reasons, in many cases, to bring the economy out of a situation of fiscal dominance, several countries not only had to implement considerable structural improvements in their fiscal position, but also renegotiate their foreign debts. They also had to implement other types of reforms that would give greater credibility to their macroeconomic management. One of them was to provide autonomy or independence to their central banks with the explicit purpose, in most cases, of avoiding financing public spending with the inflation tax, and another was for central banks to operate with an inflation targeting scheme.

However, as is well known, and in light of the use of unconventional monetary policies in the major advanced economies, both in the aftermath of the global financial crisis and more recently in the COVID-19 crisis, the line between monetary and fiscal policies has become somewhat blurred. This has not been a problem for the advanced economies; however, it has generated a debate on the implications it may have on the emerging economies.

This shows the importance of closely monitoring inflation in the context of the prudent management of public finances.

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1/ When an economy faces a shock, it is necessary to evaluate its nature. Also, it is necessary to consider that when responding to a shock using monetary policy there is a bias towards interest rates absorbing a larger portion of the shock. In responding to a shock using fiscal policy, there is a bias towards the real exchange rate absorbing a larger share of the shock. Thus, it is necessary to have both policies in place to be ready to respond.

Motivation

Fiscal and monetary policies are intrinsically linked through various channels. Moreover, the intensity of this link changes under different macroeconomic conditions and/or contingencies. A general approach considers the budget constraints of the government and the central bank as one. Thus, for example, when a government has fiscal problems, it may be forced to obtain resources from the central bank. Additionally, the relationship between fiscal and monetary policies may be subject to structural changes. Indeed, a favorable structural fiscal change may contribute to stabilizing inflation expectations or to reinforcing previously achieved stability.

The economic history of the region in the last decades of the previous century, and in some cases until more recently, was characterized by periods of instability and contrasts in policy implementation. While one might think that the causes of the crises are different in each case, the subsequent evolution of the main macroeconomic indicators followed similar patterns. In most of the crises, the underlying cause has been a fiscal one.

It is important to emphasize that fiscal problems arise not only because of the size of the expenditure, but also because of the capacity to collect taxes as a function of government spending (Esquivel, C. et al. 2019). This is determined by present tax collection and debt issuance capacity (i.e., future tax collection). The accumulation of fiscal deficits is what may generate inflationary pressures, given the possible need to finance part of such deficits with money issuance (inflation). To the extent that economies are perceived to have sufficient future revenue capacity (i.e., that they can continue to issue debt), such pressures should not be generated. However, the existence of high fiscal deficits and inflation may lead to a crisis. Under this scenario, implementing changes in the management of public finances would have to issue sufficient credibility that the government will recover its tax collection capacity in relation to its spending.

On the other hand, agents' inflation expectations depend, among other factors, on budget restrictions being met and on debt paths and fiscal deficits being sustainable. These expectations are formulated given the information that the agents have. For example, agents could formulate their expectations depending on their estimation error of the previous period. If their expectation was higher (lower) than the realized inflation, it is likely that they correct downwards (upwards). Also, if they believe that the discrepancy between their expectation and actual inflation was due to an unlikely state, they may not consider it relevant to make a correction. More generally, the formation of inflation expectations influences, to a large extent, the observed inflation.

Background

The following are some of the seminal works that have studied the interrelationship of fiscal and monetary policies.

Cagan's classic model (1956) involves a demand for money and an expectation-formation mechanism. In this model, in general, for a level of tax collection per seigniorage there are two inflationary equilibriums: one associated with a low level of inflation and another associated with a high level of inflation. Under certain conditions (which are considered reasonable), the first would be stable and the second unstable. This suggests that the transition from a high to a low inflation equilibrium implies numerous challenges and will require the implementation of various economic policies. Among these, the government's commitment to clean up public finances could be highlighted, as well as the coordination of the different agents to anchor their inflation expectations at low and stable levels.

A seminal article in this literature is Sargent and Wallace (1981). Under their model, nominal government debt is expressed in real terms as a function of expected fiscal flows and seigniorage. Under the assumption that, at the end of time, the public debt is indeed repaid, the authors add the budget constraints of the government and the central bank. If there were an expectation that fiscal flows might not be sufficient to support the real value of the nominal debt, then the inflation tax would have to increase, which would imply a raise in inflation. ^2/

Bruno and Fischer (1990) study the stability of dual inflation equilibrium under fiscal deficits financed by the inflation tax. The authors emphasize that the stability of the two inflation balances, one with high inflation and the other with low inflation, depends on the speed with which the demand for money and inflation expectations adjust to changes in inflation. ^3/

Intuitively, the authority's ability to obtain resources through the inflation tax depends on how quickly agents in the economy adjust their demand and inflation expectations. On one hand, the adjustments can be slow. In this case, agents can adjust their demand for money slowly in the face of rising inflation. Likewise, they can adjust their inflation expectations slowly. Under this scenario, the real value of resources that can be obtained by the authority through the inflation tax is greater than if both adjustments were relatively faster. Thus, a slow response by agents allows the authority to have more resources available via the inflation tax. On the other hand, adjustments can be fast. In this case, agents can adjust their demand for money quickly in the face of an increase in inflation, decreasing their money holdings. Likewise, they can adjust their inflation expectations quickly. Under this scenario, the real value of the resources the government can obtain through such a tax is lower. In sum, the relative magnitudes of the responses determine the properties of the equilibrium in question.

In Bruno and Fischer’s model, under a high inflation equilibrium, if the demand for money responds slowly to the expected inflation and the inflation expectations adapt slowly to changes in inflation, the agent is not able to adapt when changes in said inflation level are important, so the referred equilibrium is unstable. Under a low inflation equilibrium, the sluggishness of the responses corresponds to small changes in low inflation levels, so the low balance is stable. Conversely, if the demand for money responds quickly to expected inflation and inflation expectations adapt quickly to changes in inflation, the agent can adapt to important changes in inflation, so the high inflation equilibrium is stable. Similarly, by responding quickly to changes in low inflation levels, the agent responds disproportionately, making the low inflation equilibrium unstable.

Bruno and Fischer, like Cagan, use a semi-logarithmic demand for money and an adaptive mechanism of expectations formation, but, in their case, they include the government's budget restriction. In their model, the economy could be trapped in a high inflation equilibrium, even though the low inflation equilibrium is feasible, given the same public financing needs. It should be noted that, if the demand for money has a semi-logarithmic shape, then a given tax collection for the inflationary tax can be congruent with two different levels of inflation: one high, and one low (in fact, you have a "Laffer curve" for the inflation tax). In such a model, there is a unique equilibrium under certain conditions. For example, when financing deficits through bonds is allowed, keeping the nominal growth of money fixed. Intuitively, by allowing bond financing, the government gains flexibility, and by fixing the nominal growth of money, it gains credibility. This only works if the bonds finance temporary deviations from net government expenditures.

Based on the model of Bruno and Fischer, Bruno (1989) tackles the design of economic reforms. He conceives a reform as a transition from a balance characterized by high inflation, to one with low and stable inflation, which is Pareto-superior, based on some economic program. Bruno applies this logic to a program implemented in Israel to stabilize inflation. This program involved corrections in the government budget and external accounts, and the implementation of agreed price and wage increases among the different sectors in the economy. The latter with the aim of coordinating the inflation expectations of economic agents in a low and stable inflation.

It is worth mentioning that the nature of dual inflationary equilibriums of models such as those presented in Bruno (1989) and Bruno and Fischer (1990) is different from that of dual inflationary equilibriums of models such as those of Sargent al. (2009). The first difference is the characterization of the stability of the equilibriums. While in Bruno (1989) and Bruno and Fischer (1990) the stability of each equilibrium depends on the estimated values of certain parameters, in the model of Sargent et al. (2009), in general, the stable equilibrium is the one with the lowest level, and the unstable equilibrium is the one with the highest level, if they exist. Also, the comparison is not straightforward because the dual equilibriums in Sargent et al. (2009) are defined in terms of expected inflation in a framework that includes several stochastic elements in the model.

Model by Sargent, Williams and Zha (2009)

This section intuitively explains the model proposed by Sargent et al. (2009, SWZ). This is the model that is estimated and used to explore the relationship between three fundamental variables in the interaction between fiscal and monetary policies: inflation, its expectations and the fiscal deficits financed by the inflation tax. In particular, this model is estimated for some Latin American economies. Also, the results are briefly discussed based on the narrative of some of the main events in each economy.

SWZ propose a model that attempts to capture the financing of fiscal deficits through seigniorage using inflation time series as the only input. This is a nice feature of the model as there is usually less access to fiscal data. In contrast, many economies present their inflation data in a timely manner and it is reasonable to assume that, at least in relative terms, their measurement is better than that of the fiscal variables associated with the model.

The SWZ model consists of four main components: a demand for money based on expected inflation, a government budget constraint, and a process of formation of agents' inflation expectations. Likewise, fiscal deficits follow a probability distribution that depends on two parameters: their mean and their variance.

These two parameters follow, in turn, two Markov processes: one determines the value of the mean, and the other the value of the variance. The two processes are assumed to be independent. The use of Markov processes implies that the probability that a parameter changes in value depends only on the value it has in the period in question. In particular, the probability does not depend on the history of the values the parameter has had, only on the value it has. The magnitudes of the possible values that the mean and variance can take provide valuable information about the dynamics of the deficits. It is worth mentioning that the model allows to estimate the probability that a certain parameter has a specific value in a given period. In practice, it is assumed that the parameter actually has the value whose probability is the highest (with respect to the probabilities of the other parameters) in a given period. The dynamics of these probabilities are very important for the interpretation of the results. Naturally, they are reported.

Although this type of model estimates the value of each of the parameters, the total number of parameters must be determined before the final estimation. Thus, there are several options. First, assume the number of values for each parameter of the model, which is usually done based on previous knowledge of the data or the model. Second, estimate the model with different numbers of parameters and implement tests to determine the best fit between them. In any case, the main interest is that the estimates are economically reasonable and have some congruence with major economic events.

In general, for each value of the average deficit, the model has two balances, which are associated with two levels of inflation expectations, one high and one low. In these equilibriums, the inflation expectations of the agents are a good approximation to the expected inflation, conditional on a value of the average of the deficit. These balances are called Self-Confirming Equilibriums (SCE). de los agentes This approach is better to the extent that the probability that the mean value is maintained is close to one. In practice, this probability is usually close to one. 4/ The SCEs are the equilibriums equivalent to the equilibriums in Cagan's classical model (1956). The SCEs can be interpreted as more general equilibriums.

Similar to the referred model, the equilibrium associated with the high level of inflation is unstable. Conversely, the equilibrium associated with the low level of inflation is stable. More specifically, the stable interval of the equilibrium associated with the low level of inflation is found between zero and the equilibrium associated with the high level of inflation. On the contrary, if expected inflation is higher than the equilibrium associated with the high level, then the expected inflation would grow without limit. In other words, the fact that expected inflation is above the high inflation equilibrium implies that it would become unstable. ^4/ The model allows for the estimation of the probability that the expected inflation is higher than the high equilibrium level, which would become unstable, as already indicated. This probability is called the escape probability. To avoid an escape event, authorities can implement some kind of reform

Intuitively, a reform involves making the level of expected inflation stable. Also, it can be interpreted to involve preventing expected inflation from becoming unstable. This can be achieved in two ways in this model.

First, if you change the expected inflation directly to a stable interval. In SWZ, it is reset to a sufficiently low (random) level. Second, if the average of the deficit changes from one value to another in such a way that the expected inflation remains in the stable interval. This is because a transition of the average deficit from one value to another modifies the equilibriums of expected inflation and, notably, the stability interval of expected inflation. A decrease in the deficit average makes the stability interval larger.

In the model, when a reform occurs without a transition for the mean parameter to a smaller value, it is called a cosmetic reform. On other hand, if the reform involves a transition from the mean parameter to a lower value so that expected inflation is in a stable interval, it is called a fundamental reform. In principle, it is not ruled out that the two types of reform could take place at the same time. However, this would be unusual. Also, based on the estimates, the interpretation is that a fundamental reform is more difficult to achieve.

2/ More generally, seigniorage is understood as the sum of the monopoly income, since the state is the only issuer of the currency in a given district, and of the inflation tax.

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3/ Analytically, it depends on the product of the semi elasticity of the demand for money with respect to the expected inflation (𝜆) by the weight (𝜈) that the agent gives to the observed inflation, in the formation of the expected inflation. The weight (1-𝜈) is assigned to the previous period's expected inflation. Specifically, if your product is less than one (𝜆𝜈 < 1), the balance of low-level inflation is stable and the balance of high-level inflation is unstable. On the other hand, if your product is larger than one (𝜆𝜈 > 1), the low-level inflation balance is unstable and the high-level inflation balance is stable.

4/ The estimation of the SCE involves solving a set of differential equations. For further details on the determination of such equations please refer to Sargent et al. (2009) or Ramos-Francia et al.

General considerations

Our estimates for each country are a work in progress . While for each estimate we impose a number of regimes for the mean and process variance of the deficit, these must be determined using some reporting criteria.

You can go directly to the estimates and discussion for each country by clicking on their respective name.

About the estimates for each country

Brazil:
We assume that the number of regimes for the mean and the variance of the process that the deficit follows is 2 and 3, respectively. This, to make a direct comparison with SWZ, who determine that these are the optimal numbers for such regimes, according to the sample they use. It should be noted that this number of regimens could change when considering different samples.

Chile:
We assume that the number of regimes for the mean and the variance of the process that the deficit follows is 2 and 3, respectively. This, to make a direct comparison with SWZ, who determine that these are the optimal numbers for such regimes, according to the sample they use. It should be noted that this number of regimens could change when considering different samples.

Mexico:
We assume that the number of regimes for the mean and the variance of the process that the deficit follows is 3 and 2, respectively. This allows us to have estimates consistent with the relevant economic events for the Mexican economy. As mentioned, the number of regimes must be determined using some information criteria.

Peru:
We assume that the number of regimes for the mean and the variance of the process that the deficit follows is 3 and 2, respectively. This, to make a direct comparison with SWZ, who determine that these are the optimal numbers for such regimes, according to the sample they use. It should be noted that this number of regimens could change when considering different samples.

Uruguay:
We assume that the number of regimes for the mean and the variance of the process that the deficit follows is 2 and 2, respectively. This allows us to have estimates consistent with the relevant economic events for the Uruguayan economy. As mentioned, the number of regimes must be determined using some information criteria.

1. Bruno, M. (1989). Econometrics and the Design of Economic Reform. Econometrica , 57(2), pp. 275-306.

2. Bruno, M., & S. Fischer (1990). Seigniorage, operating rules, and the high inflation trap. The Quarterly Journal of Economics , 105(2), pp. 353-374.

3. Cagan, P. (1956). The monetary dynamics of hyperinflation. In Studies in the Quantity Theory of Money, edited by Milton Friedman. University of Chicago Press.

4. Esquivel, C., T. J. Kehoe & J. P. Nicolini (2019). Lessons from the Monetary and Fiscal History of Latin America. University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2019-47.

5. Ramos-Francia, M., S. García-Verdú, & M. Sánchez-Martínez (2018). Inflation Dynamics under Fiscal Deficit Regime Switching in Mexico. Banco de México, Working Paper 2018-21. URL

6. Sargent, T. and N. Wallace (1981). Some unpleasant monetarist arithmetic. Federal Reserve Bank of Minneapolis Quarterly Review , 5(3), pp. 1–17.

7. Sargent T., N. Williams and T. Zha (2009). The Conquest of South American Inflation. Journal of Political Economy , University of Chicago Press, 117(2), pp. 211-256.