Non‐nested hypothesis testing of theories of inflation in Latin America

There is a lively debate among the monetarists and the structuralists in explaining the persistence of inflation in Latin American countries. The monetarists point out the role of excess demand in generating inflation. On the other hand, the structuralists point out the role of structural factors; agricultural bottleneck, foreign trade bottleneck, and public sector bottlenecks in causing inflation. In this paper we conduct non‐nested hypothesis testing of the structuralist and the monetarist theories of inflation using data for a set of Latin American countries. No general pattern emerges from the tests. In the case of individual country studies the results are mixed. For some countries the tests rank the monetarist model over the structuralist model, while for some others they either accept or reject both models. In the pooled sample there is even less variation in the results. In most of the cases the tests accept both models, suggesting that it is not possible to differentiate between the models. The results of the paper casts serious doubt on the applicability of monetarist and structuralist theories in explaining inflation in Latin America. The conclusion of the paper may be able to explain why in the past stabilization programmes based either on monetarist or structuralist ideas have failed miserably in controlling inflation in Latin America.