What Can Taylor Rules Say About Monetary Policy in Latin America?

This paper examines the way monetary policy has been conducted recently in the seven largest Latin American economies, the LAC-7 group. We run eight alternative specifications for the Taylor rule and select the most appropriate functional form through out-of-sample measures of forecasting performance. The comparison indicates that backward-looking rules slightly outperform forward-looking ones in forecasting interest rates, hinting that past inflation is still an important determinant of expected inflation in emerging countries. As regards the interest rate setting, we find evidence that only Mexico has followed the Taylor principle in recent years, and even so not all the time. Seemingly, although Brazil and Chile have followed the principle marginally, the remaining countries have carried out neutral monetary policies with respect to inflation. Our results also suggest that, for most countries, the interest rate setting is symmetric and does not take into account Exchange rate changes or the output gap.