Exchange market pressure, commodity prices, and contagion in Latin America

Abstract

Over the past two decades, Latin American currencies have faced not only pressure to devalue but also periods of uncomfortable appreciation. Domestic macroeconomic factors, as well as global events and contagion, might bear part of the responsibility. This study constructs a monthly index of exchange market pressure (EMP) for four Latin American countries before using vector autoregressive methods to test the influence of commodity prices, macroeconomic variables, and external factors on each country's index. While inflation is an important determinant of EMP, we conclude that Chile and Peru are more likely than Mexico and Brazil to face pressure when commodity prices fall. This supports the idea that these two countries have “commodity currencies” and that their exchange markets are most vulnerable to international contagion.

Keywords:

• exchange market pressure
• commodity prices
• contagion
• vector autoregression

JEL Classifications:

• F31
• F41

Acknowledgements

I am especially thankful for the helpful comments of two anonymous referees. Any remaining error, however, is mine.

Notes

1. Re-estimating Brazil's VAR for the post-hyperinflation period, beginning in 1996:1, provided similar results with respect to the role of commodity prices on the exchange market and what appears to be a weakly negative contribution by inflation. Credit growth's impact disappears, however.