MNI INTERVIEW: Latam Neutral Rates Stable Through Pandemic

The pandemic and subsequent supply-side shocks had little effect on the neutral real rates of interest for Brazil, Mexico and Chile, according to a market-based measure that suggests policy reached highly restrictive levels in all three countries by late last year, one of the authors of a Federal Reserve Bank of San Francisco working paper told MNI.

In findings the authors believe could extend across other emerging markets, they detected relatively stable real neutral rates despite sometimes violent moves in short-term yields.

"Since the beginning of the pandemic, we have noticed increased ups and downs in long-term yields across many advanced and Latin American economies. This can be attributed to significant shifts in term and liquidity premiums embedded in government bond yields," Luis Ceballos, a professor at the University of San Diego, said in an interview.

The research, co-authored by SF Fed advisor Jens H. E. Christensen and Damian Romero, an economist at the Central Bank of Chile, finds the average real neutral rate is 4.51% for Brazil, -0.77% for Chile, and 2.80% for Mexico, according to Ceballos, also a former senior economist at the Central Bank of Chile.

"We pinpoint the neutral interest rate by excluding these premiums, which have played a pivotal role in long-term yields. Consequently, after removing term and liquidity premiums, we find that the natural rate has not shown significant fluctuations. This leads us to underscore the policy implications of separating the effects of these premiums in the dynamic of long-term yields," he said.

Since the measures of the natural real rate of interest are based on forward-looking information, the data can be updated on a daily basis.

"They could serve as an important input for real-time monetary policy analysis," the authors wrote in the working paper.

SOURCES OF VARIANCE

While Brazil's rate is higher and more volatile, Mexico's is elevated but stable, while Chile's is low and has persistently declined, the research shows. (See MNI INTERVIEW: Copom At Ease With Market Rate Pricing-Kfoury)

The study found that while policy turned accommodative relatively early in the pandemic in all the economies studied, it was highly restrictive by historical standards by the end of the sample period in September 2023. This underscores the need for policy rates to be lowered as inflation declines towards target, the paper said.

Ceballos said natural rates across the three Latin American economies might differ due to variations in macroeconomic factors, such as productivity growth and changes in demographics impacting investment savings for extended retirements. (See: MNI INTERVIEW: Dovish Banxico More Data-Dependent-Ex-Economist)

"Differences in fiscal policy, with higher government borrowing leading to higher rates, also play a role. Lastly, variations can reflect differences in financial drivers, such as risk aversion and leverage cycles in these countries,” he said.

“While our paper doesn't explicitly factor in these elements, we start with the assumption that current long-term interest rates already reflect differences in these macroeconomic factors.”

Chile has consistently shown one of the lowest credit risks in the region, translating into higher debt ratings due to a predictable countercyclical fiscal policy that limited government debt during the 2000s – and resulting in a lower neutral interest rate as well, he said.