Financial constraints and inflation in Latin America: The impacts of bond financing and depreciations on supply inflation

This paper attempts to provide empirical evidence on whether two variables potentially affecting firms’ liquidity needs have an impact on inflation. Before doing that, since we are interested in the portion of inflation that can be linked to firms’ willingness to produce goods, we identify supply inflation: the part of aggregate GDP-inflation that can be explained by shifts in aggregate supply. Specifically, we test the impacts of corporate bond financing and depreciation on supply inflation and markups for several Latin American countries. Results show that domestic currency depreciation robustly increases supply inflation and aggregate markups, but corporate bond financing does not affect supply inflation. Presumably, when a depreciation occurs, financial constraints for the economy’s supply-side become binding and lead to increasing domestic prices. These results provide an alternative description to the exchange rate pass-through narrative. In several countries, since a sizable part of depreciation can be explained by the global financial cycle, there is also a potential transmission mechanism from advanced countries’ monetary policy actions to supply inflation – through depreciation – in Latin American countries.