Weather shocks and inflation expectations in semi-structural models

Colombia is particularly affected by the El Ni & ntilde;o Southern Oscillation (ENSO) weather fluctuations. In this context, this study explores how adverse weather events linked to ENSO affect inflation expectations in Colombia and how to incorporate these second-round effects into a small open economy New Keynesian model. Using BVARx models, we find evidence that inflation expectations - obtained from surveys and break-even inflation measures - are influenced by weather-related supply shocks. Building on this stylized fact, we modify one of the core forecasting models of the Banco de la Rep & uacute;blica to incorporate the mechanisms through which weather-related shocks could affect marginal costs and inflation expectations. We conclude that ENSO shocks play a significant role in influencing both inflation and the dynamics of inflation expectations, a fact that should be considered by policymakers.