ABSTRACT
Colombia has been on a steady disinflation path since the early 1990s. This chapter presents the transmission mechanism of monetary policy during this disinflation. It describes how inflation evolves in response to important shocks that occurred during disinflation such as the terms of trade and to the risk premium, and compares the responses across different monetary policy rules and under different assumptions about inflation persistence. At that time the crawling exchange rate band had to be defended in the face of a risky international environment and a deterioration of the domestic political situation. The low real interest rates of 1992 may have contributed to relatively low unemployment, at levels probably below the natural rate. As a consequence, inflation peaked at over 30 per cent in 1992 and only began decreasing thereafter when high real rates pushed up unemployment again.
