Colombia: Selected Issues

This Selected Issues paper focuses on the impact of fiscal and monetary policies on inflation in Colombia. Colombia, as many other emerging market economies, has been particularly susceptible to shocks that pushed inflation above central bank targets and lowered growth. Following a series of supply-side shocks, unprecedented policy stimulus, and a sharp recovery in economic activity after the pandemic, inflation rose above central bank targets in many economies around the globe, including Colombia. Amid a more challenging external backdrop and increasing monetary policy trade-offs, this note explores the role that fiscal policy can play to support monetary policy in addressing inflationary pressures without unduly dampening growth. Lower (larger) fiscal adjustment, in the form of expenditure cuts, is indeed associated with lower (larger) overall demand adjustment and more (less) aggressive monetary policy tightening. At the same time, a faster reduction in inflation takes place when fiscal consolidation supports the monetary policy response. The empirical analysis and calibrated model suggest that fiscal policy can play a critical in role in tackling inflation, with important welfare enhancing implications.