Thursday, November 29, 2012

Despite a Recent Rise in Inflation, Mexico’s Central Bank Keeps Its Interest Rate Unchanged

Inflation—a general rise in the price levels of goods and services, which causes a decrease in the purchasing power of money—has become a concern for Mexico. One of the main tools to stop rising inflation is to increase the country’s interest rate. A higher interest rate increases the cost of borrowing, which decreases the amount of money in the economy. When there is less money, consumers tend to spend less and demand less goods and services, which lowers the price level of those goods and services, and, thus, lowers inflation. However, Mexico currently does not want to increase interest rates because the country wants to stimulate growth in its economy—a low interest rate stimulates investment, which helps boost the economy. Mexico’s central bank must balance the concern of controlling inflation with its attempts to stimulate the economy.

According to the central bank, the targeted range for inflation in Mexico is between 2% and 4%. The inflation rate has been outside this range since May 2012, when the rate began to rise (3.41% in April 2012 to 3.85% in May 2012). The inflation rate continued to rise until October 2012, when the rate fell from 4.77% in September 2012 to 4.64% in October 2012. Due to this recent inflation shock, the central bank considered increasing the interest rate. However, on October 26, 2012, the central bank’s Governor Augustin Carstens announced that the interest rate would remain at 4.5%.

The central bank’s decision to keep the interest rate unchanged reflects its view that the inflation shock is temporary, as the pressures causing the inflation rate to rise are short-term. The recent drought and outbreak of bird flu decreased the food supply, which caused price levels to increase, especially for eggs and chicken. Mexico also has a low unemployment rate, which recently hit pre-recession levels—4.68% in September 2012. Since more people are employed, they have more money to spend, which increases demand and, thus, price levels. But, this drop is potentially short-term because the rate quickly began to increase in October 2012 (4.83%). Moreover, these inflationary pressures are counter-balanced by the recent quantitative easing policies of the United States (injecting new money into the economy), which will cause the peso to appreciate versus the dollar and result in cheaper imports. Economists also predict slower growth in the Mexican economy: between 3.5% and 4% in the second half of 2012, compared to the 4.3% growth in the first half of 2012. Slower growth leads to decreased demand, which keeps prices down.

The Mexican central bank kept the interest rate unchanged because the need to boost the slowing economy outweighed the need to control the temporary rise in inflation. Economists predict that the decrease in economic growth in the second half of 2012 will continue in 2013, as growth will drop to 3.3%. Economic growth is important because it generally improves the population’s standard of living and reduces poverty. Despite the need to stimulate economic growth, Governor Carstens reaffirmed the central bank’s commitment to lowering inflation into its targeted range and warned that the central bank would increase the interest rate if the inflation shock persists.

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