WASHINGTON—At the beginning of this year, Latin America’s central banks had every reason to cut interest rates. Economic growth was slowing and domestic consumption rates remained stubbornly low. Yet many central banks still apparently felt that they had limited room to act. Mexico made two small cuts before pausing in June and signaling that its 6.5 percent rate would remain in place for some time. Brazil delivered a cautious quarter-point cut in June, even as its rate remained near the two-decade high reached in 2025, with another decision looming in the coming days. Colombia went the other way, raising its rate, before holding steady last week.
The obvious reason for these changes is inflation. Central banks set a target for inflation rates in their countries and then adjust interest rates to hit that target. But inflation has been a challenge this year. In February, the conflict in the Middle East disrupted trade, driving up energy, fertilizer, and food prices around the world. While a brief ceasefire in the Iran war gave many hope that inflation would cool, the conflict’s resumption has pushed oil prices back up again.
Inflation explains only part of the story, however. Some central banks, such as the ones in Chile and Peru, can wait calmly, holding real rates (the difference between their interest rate and the inflation rate) barely above zero without market punishment. Part of the reason could be that these central banks feel less pressure, since investors largely trust these governments with their spending, decreasing the likelihood that keeping interest rates low would trigger capital flight or a failing currency. On the other hand, Brazil, where significant debt and persistent deficits leave investors less convinced, keeps one of the highest real rates in the world. Colombia’s decision to raise rates this year was widely expected after the government continued to spend more than it collected.
The difference for these central banks, therefore, appears to be whether markets trust the fiscal outlook in the country, even though that is supposed to be separate from the central bank’s monetary mandate. Elections and government transitions add to the calculations these central banks appear to be making. High public expenditure from governments in Colombia, Peru, and Brazil, for example, creates pressure on central banks to push rates higher to make such spending feasible. This runs the risk of blurring what should be a more fixed division between monetary and fiscal policy.
Where the pressure begins
One issue is taxes. On average, Latin American governments collect 21.7 percent of their gross domestic product (GDP) in taxes. This amount is less than in many developed economies. For example, the average for the thirty-eight Organisation for Economic Co-operation and Development (OECD) members is close to 34 percent of GDP. Moreover, the gap between the two groups has barely moved in a decade.
A thin tax base makes debt expensive to carry. Debt service in 2023 absorbed 13.5 percent of the region’s tax revenue, up from less than 10 percent a decade earlier. This indicates that a larger share of public resources is being used to service debt, reducing fiscal space for investments in development, social programs, and economic growth. Raising interest rates increases the bill further, tying each central bank’s decision to its government’s balance sheet, no matter the constraints on a central bank’s mandate.
Colombia is the cautionary case. Its inflation challenge is increasingly tied to fiscal credibility, or the extent to which the public has faith in the government to achieve its spending and debt-management plans. In 2025, the Colombian government set aside a legal restriction it placed on government spending and debt, and the consequences arrived in order: downgrades in the country’s credit scores, the finance minister’s departure, and a weaker peso. Meanwhile, inflation continued to climb, and it is now above 6 percent. Investors began charging more to hold Colombian debt, and the central bank responded by raising rates to 12 percent in June of this year.
Now, the Colombian central bank is keeping its real rates elevated, to defend the peso and to re-anchor inflation expectations. Meanwhile, Chile and Peru absorbed the same inflation shock related to the Iran war, but neither is about to raise rates: Their real rates sit only just above the US level. That can be attributed to each government’s fiscal credibility. They can wait on adjusting interest rates without responding to market pressure (and there is less of it) until the move on rates is more aligned with their inflation-controlling mandate.
The problem will not go away on its own
This issue is structural; it is persistent across administrations. The region’s tax take is small and leans on consumption taxes rather than income taxes. Its populations are aging fast: fertility fell below replacement around 2015, and the ratio of retirees to workers is set to roughly double by 2050. Pension and health spending will only rise for decades.
With about half the workforce in the informal economy, a narrow base of formal workers must fund those promises. Governments that cannot raise more revenue and will not trim commitments end up borrowing, and the pressure lands back on their central banks.
The first half of 2026 leaves a plain lesson: In Latin America, fiscal credibility protects the space that central banks have to adjust rates based on their inflation mandate. Credible fiscal forecasts let central banks wait without incurring devastating costs and move when it matters. In countries where there is weak fiscal credibility, central banks may feel more tempted to keep rates higher for longer, even when inflation slows. This will continue to be the case as governments in the region face new challenges, including how to attract foreign investment (particularly from the United States) to increase job creation, expand export capabilities, and meet pressing social needs.
This trend matters for Washington
Fiscal credibility has direct consequences for the United States. When a Latin American government loses its fiscal credibility among its public and markets, the effects ripple north through three channels: weaker growth that adds to migration pressures, less stable partners for nearshoring and supply-chain resilience, and greater risk for US investors exposed to the region’s sovereign debt.
This piece is part of “Economic Pulse of the Americas,” a series of explainers about the overlooked economic and trade trends in Latin America and the Caribbean, written by the Atlantic Council’s Adrienne Arsht Latin America Center. To get notified about future editions and other related work on the region, sign up here.