The role of external shocks for monetary policy in Colombia and Brazil: A Bayesian SVAR analysis

This paper identifies the effects of US interest rate and commodity price shocks on the monetary policy of two inflation targeting emerging economies from Latin America, Colombia and Brazil. We estimate country-specific Bayesian SVARs with block exogeneity restrictions and account for the fact that central banks in both countries use two different instruments of monetary policy, a policy interest rate and foreign exchange market interventions. Our findings show that the Colombian and, to a lesser degree, the Brazilian central bank use sterilized interventions as a systematic component of their inflation targeting regimes, which are more accurately described as "inflation-targeting-cum-intervention". Foreign exchange interventions are used in both countries to set domestic interest rates more independently from US monetary policy and, in Colombia, to increase interest rates in response to rising import prices without further deteriorating the terms of trade. Our results also indicate a lower susceptibility to shocks emanating from outside Colombia or Brazil under this policy regime than what studies for the pre-infl ation targeting period have found.