The Quest for Price Stability in Central America and the Dominican Republic

Abstract

Why hasn’t inflation converged to price stability in Central America and the Dominican Republic? Why is it currently still high by Latin American standards? This paper addresses these questions, and finds that despite the institutional strengthening of monetary policy, important flaws remain in most central banks, in particular the lack of a clear policy mandate and little political autonomy, which are hurting the consistency of policy implementation. Empirical analysis reveals that all central banks raise interest rates to curtail inflation, but only some of them make large enough increases to effectively tackle inflation pressures. It also shows that some central banks care simultaneously about exchange rate stability. The potential policy conflict arising from a dual central bank mandate and the unpredictable policy response is probably undermining market confidence in central banks’ commitment to price stability, thereby perpetuating an inflation bias.