Exchange rate misalignment and inflation rate persistence: Evidence from Latin American countries

Abstract

This paper tests the conjecture that inflation rate persistence in selected Latin American countries, namely Brazil, Mexico, Uruguay and Venezuela, is related with currency undervaluation. In this manner, we expect that the behaviour of inflation rates may be non linear reflecting the changing status of the exchange rate. By modelling an appropriate non linear model, we find no strong evidence in favour of the above commonly accepted view. However, our evidence shows that in periods of high depreciation of the home currency the domestic inflation rate was persistent, while in periods of slower depreciation, or relative stability, it was transitory.