The objective of monetary policy in Colombia is to maintain a low and stable inflation rate and to attain a maximum sustainable level of output and employment. In this way, monetary policy fulfils the Constitutional mandate to maintain the purchasing power of the peso and contribute to improve the well-being of the population.
To achieve its objectives, Banco de la República (the Central Bank of Colombia) follows an inflation targeting strategy in a flexible exchange-rate regime. Under this scheme, monetary policy actions aim for future inflation to stand at the target set out in the policy horizon. In Colombia, the target was set by the Board of Directors of the Central Bank at 3.0% (with a deviation range of ±1 percentage point). This target refers to consumer price inflation, which is measured statistically as the annual variation of the Consumer Price Index (CPI).
With the purpose of achieving the inflation target, the Central Bank sets the benchmark interest rate, also known as the monetary policy interest rate or intervention rate. The Bank adjusts the money supply to ensure that the overnight Reference Banking Indicator (IBR) is close to the monetary policy interest rate. Changes in the benchmark rate affect inflation and short-term growth through various transmission mechanisms.
The flexibility of the exchange rate that accompanies the inflation targeting strategy has two objectives. First, it allows the Central Bank to have an independent monetary policy that takes the situation of the Colombian economy into account, enabling it to fulfill its constitutional mandate. Second, the flexible exchange rate softens the effect that external shocks such as changes in the international prices of oil could have on the economy.