How Will the Food Price Shock Affect Inflation in Latin America and the Caribbean?

There is widespread concern that recent increases in international food prices may have significant effects on domestic food prices and inflation. This note assesses the impact of the recent food price shock on food, non-food and consumer inflation in the countries of Latin American and the Caribbean (LAC). Vector Autoregressive Regressions (VARs) are estimated for each country to trace the effect of international food prices, the price of oil and the value of the US dollar on domestic prices. The results are then used to calculate the potential impact of higher food prices and to project the expected rise in domestic prices to the end of 2011 and beyond, given the actual increase in food prices until February 2011. It is concluded that, due to the food price surge, increases in inflation could exceed 5 percentage points in Bolivia, Dominican Republic, Guatemala and Honduras unless additional policy actions are taken. In some countries with flexible exchange rate systems, such as Brazil, Colombia and Mexico, currencies tend to appreciate as a response to higher food prices and as a result the impact on domestic prices is muted. However, there is no simple pattern of differences between floaters and fixers; the speed and extent of pass-through is quite heterogeneous and dependent on factors such as the importance of food in the overall inflation index and local policy measures.