The Hidden Easing: Why Policy Stance Is More Accommodative Than It Appears in Central America, Panama, and the Dominican Republic

The global economic cycle has shifted rapidly from post-pandemic soaring inflation to the fastest tightening of interest rates in a generation, and now to a gradual monetary normalization. 

Against this backdrop, CAPDR faces a key question: how should we interpret the stance of monetary policy when inflation, expectations, and structural conditions are moving simultaneously? The answer requires looking beyond headline rates and understanding where policy stands relative to the neutral rate — the threshold that determines whether interest rates are effectively pushing the economy upward or pulling it downward.

After one of the sharpest global inflation shocks in decades, central banks across CAPDR responded with speed and technical discipline, tightening policy decisively to anchor expectations and prevent price pressures from becoming entrenched. This decisive adjustment is visible in Figure 1, which shows the sharp increase in policy rates during 2022 and early 2023, followed by a gradual decline as inflationary pressures eased — reflecting the continued importance of credibility and forward-looking guidance.

Inflation dynamics reinforce this narrative. Figure 2 shows a broad and sustained decline in headline inflation throughout 2023 and 2024. The easing of core inflation across most economies signals that domestic price pressures have also moderated, not just imported shocks. Together, these trends indicate that the impact of earlier tightening has filtered through the economy, aligning inflation outcomes with medium-term objectives.

In monetary analysis, however, the stance of policy is defined not by the direction of interest rates, but by their position relative to the neutral rate. When policy rates remain above that level, monetary conditions are still restrictive, even if rates are declining. Only once they move below it does policy become genuinely accommodative.

This combination of anchored expectations, improving inflation profiles, and gradual easing has positioned CAPDR favorably compared to global peers, with normalization proceeding prudently and reflecting careful calibration and strong communication.

As this transition unfolds, the key question becomes how to interpret the stance of monetary policy when policy rates, inflation, expectations, and structural conditions are all shifting at once.

A common misconception is that a lower policy rate automatically signals an accommodative stance. In practice, what matters is how the policy rate compares with the neutral rate, the level consistent with stable inflation and output at potential. When the policy rate stands above neutral, policy is contractionary; when it falls below it, policy becomes accommodative.

During the inflation surge of 2021 and 2022, central banks across CAPDR raised policy rates well above neutral to contain price pressures. As inflation has moderated and expectations remain anchored, rates have gradually moved back toward neutral territory. Figure 3 illustrates this adjustment: the gap between the real policy rate and its estimated neutral level has narrowed since mid-2023, signaling a shift away from clearly contractionary territory. Although nominal rates remain elevated, the decline in the neutral rate implies that the overall stance is less restrictive than it may appear at first glance.

The key insight for CAPDR is that the neutral rate itself has declined. Estimates based on semi-structural frameworks point to three drivers: easier global financial conditions, softer potential growth, and lower sovereign risk premiums. As spreads have narrowed across several countries, financing costs have fallen, pushing the neutral rate downward.

This shift helps explain why the region’s monetary stance may be more accommodative than headline rates suggest. Even if nominal policy rates remain elevated, the distance to the neutral rate has decreased, signaling a less restrictive environment than during the peak of the inflation episode.

The neutral rate reflects structural and financial forces. In CAPDR, potential growth has moderated since the pandemic, while global financial conditions have eased. Most importantly, sovereign risk has declined. As shown in Figure 4, falling spreads have exerted sustained downward pressure on the neutral real rate, expanding the room for policy normalization without jeopardizing price stability.

Potential growth is the structural anchor of the neutral rate: stronger long-term growth raises returns and pushes it upward. However, the post-pandemic slowdown and a more moderate global outlook have softened this component across several CAPDR economies.

External conditions also play a decisive role. In financially open and partially dollarized economies, the stance of the U.S. Federal Reserve shapes domestic financial conditions. As the Fed eases, the external component of the neutral rate tends to decline, giving small economies more room to adjust their own rates without generating instability.

The most important driver today, however, is sovereign risk. As shown in Figure 4, risk-premium shocks have turned increasingly negative for the CAPDR-5 average: as sovereign spreads have fallen, they have exerted sustained downward pressure on the neutral real rate. Lower perceived risk reduces financing costs and, in turn, lowers the interest rate consistent with stable inflation and balanced economic activity.

These factors explain why neutral rates are falling across CAPDR and why normalization is occurring at different speeds. The region is adjusting to a structural environment in which the neutral rate itself is lower. 

A notable feature of CAPDR’s post-pandemic macroeconomic landscape is the emergence of a more favorable policy mix. As monetary policy has moved toward neutrality, improvements in macroeconomic fundamentals have helped reduce sovereign risk premiums across several countries.

Figure 4 illustrates this shift. Risk-premium shocks that once pushed the neutral rate upward have reversed since 2023, as falling sovereign spreads now exert downward pressure. As the neutral rate declines, central banks gain more room to move from a contractionary stance toward neutrality without undermining credibility.

Together, these trends — supported by stronger fiscal balances, including primary surpluses close to 1.4 percent of GDP in several countries — create a more supportive macroeconomic environment: lower sovereign spreads, lower neutral rates, and greater room for monetary easing while preserving progress on inflation.

By 2025, CAPDR stands in a firmer macroeconomic position than many expected at the start of the global inflation shock. Inflation has moved back toward targets, expectations remain anchored, and the region’s central banks have demonstrated a disciplined and well-calibrated response to an exceptionally volatile environment. This foundation has allowed monetary policy to enter a phase of gradual normalization guided by data, credibility, and technical rigor.

Yet the path ahead requires more than adjusting policy rates. The stance of monetary policy depends on how far rates sit from their neutral level, and that benchmark has shifted downward as risk premia have declined and macroeconomic fundamentals have strengthened. This has created room to move from a contractionary stance toward neutrality without compromising price stability.

The challenge now is to preserve this favorable mix. Stronger institutions, credible policymaking, and a continued commitment to prudent macroeconomic management will be essential to sustain the gains achieved so far. When fiscal and monetary policy reinforce each other, they reduce vulnerabilities and expand the room for growth-supporting measures. CAPDR’s recent experience shows that this combination is both feasible and effective: with the right policy mix, the region can navigate global uncertainty while advancing toward a more stable and resilient economic future.