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Macroeconomic Policy and Economic Performance: Chile’s
Recent Experience
Luis F. Céspedes
Ministry of Finance-Chile
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Macroeconomic Policy and Stabilization
• External shocks, such as terms of trade and world interest rate shocks are key driving forces behind business cycle in emerging market economies.
• Economic stabilization depends crucially on the macroeconomic framework: monetary policy, fiscal policy and exchange rate regime.
• Reaction to shocks: countercyclical or pro-cyclical?– Maintain (reduce) interest rates and allow depreciation? – Raise interest rates to avoid depreciation and inflation? – Expansionary fiscal policy?
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GDP Accumulated
LossesDuration
Initial fall in GDP
Chile 82 34,5% 7,0 -13,6%Chile 99 10,7% 6,0 -0,8%Mexico 95 10,7% 3,0 -6,2%Korea 98 11,1% 2,0 -6,7%Indonesia 98 22,6% 6,0 -13,1%Colombia 99 9,9% 5,0 -4,2%Ecuador 99 9,6% 3,0 -6,3%Latin America 81-82 24,6% 6,6 -4,2%Average Sample 13,6% 4,6 -2,1%
Latin America 81-82: Brazil, Bolivia, Costa Rica, Ecuador, Uruguay.
Cost and Duration Recessions: Selected Experiences
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Chile: Policy Framework
• Flexible Inflation Targeting– Inflation target band: 2-4%.– Medium run horizon.
• Free-floating exchange rate regime.– Foreign exchange interventions under special circumstances.
• Fiscal Rule– Structural fiscal balance
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Chile: Policy Framework
• Recent evidence indicates that macroeconomic volatility has been significantly reduced in recent years.
• The implementation of a flexible and credible inflation targeting regime has allowed monetary policy to play a key stabilizing role.
• Fiscal Policy has also been key to reduce the effects of external shocks in activity and in the competitiveness of the economy.
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GDP volatility has decreased in recent years
0%
3%
6%
9%
12%
15%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Volatilidad
1990-1996 1997-2002
2003-2007
1980-1989
Sources: Ministry of Finance and Central Bank of Chile.
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Central Bank has been able to implement a countercyclical monetary policy
Sources: Ministry of Finance and Central Bank of Chile.
1234567
Dic-01 Jun-02 Dic-02 Jun-03 Dic-03500
550
600
650
700
750
800
Interest Rate Exchange Rate
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Fiscal Policy
• A credible fiscal policy is crucial to isolate government expenditure from economic fluctuations.
• During booms, higher fiscal savings reduce pressures on aggregate demand which stabilizes economic activity and the real exchange rate.
• Evidence indicate that in many developing economies, fiscal policy is pro-cyclical. Moreover, it is common that fiscal expenditure increases in a higher proportion than fiscal revenues during good times.
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Fiscal Policy in Chile
• Government expenditures are determined by medium and long term fiscal revenues (structural revenues).
• Structural revenues are a function of potential output and the “reference” price of copper.
• During recessions the government borrows and during expansions it saves.
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Fiscal Policy in ChileFiscal Surplus
2,2%
4,7%
-0,5%-0,5%
-1,2%
-2%
-1%
0%
1%
2%
3%
4%
5%
2001 2002 2003 2004 2005
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External conditions have been favorable for the Chilean economy in recent years.
50100150200250300350400
Ene-0
0
Jul-0
0
Ene-0
1
Jul-0
1
Ene-0
2
Jul-0
2
Ene-0
3
Jul-0
3
Ene-0
4
Jul-0
4
Ene-0
5
Jul-0
5
Ene-0
6
Jul-0
6
Fuente: Cochilco
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Fiscal Policy in ChileFiscal Surplus
-4,0%
-3,0%
-2,0%
-1,0%
0,0%
1,0%
2,0%
t-1 t t+1
Chile 1982 Chile 1999 Chile 2001
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Fiscal Policy in ChileGovernment Expenditure
-5,0%
-2,5%
0,0%
2,5%
5,0%
7,5%
t-1 t t+1
Chile 1982 Chile 1999 Chile 2001
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By increasing fiscal saving during good times, fiscal policy has reduced the appreciation of the RER
Sources: Ministry of Finance and Central Bank of Chile.
Average Price of Copper
% RER
Cycle 1994-1997 111,3 -8,4%Cycle 1998-2003 75,3 18,7%Cycle 2004-2006 173,9 -1,8%
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Fuente: Banco Central.
Real Exchange Rate
75
80
85
90
95
100
105
110
115
Jun-86 Jun-90 Jun-94 Jun-98 Jun-02 Jun-06
75
80
85
90
95
100
105
110
115
Average 1990-2006 RER RER
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Gross Debt Public Sector (% of GDP)
Source: Ministry of Finance
0%
10%
20%
30%
40%
50%
60%
70%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
(p)
Gross Debt Central Government Gross Debt Central Bank
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Portfolio management has also being consistent with keeping “competitiveness” of the economy
Financial Assets of the Treasury
71,3%81,6%
18,4%28,7%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
April 2006 June 2006
Foreign Currency
Pesos
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• Complements the Structural Balance Rule by focusing on the management of the financial assets generated by the implementation of the rule.
• Includes the creation of two funds: the pension reserve fund and the economic and social stabilization fund.
• Improves transparency of fiscal policy and financial asset management.
• Empowers the Government to capitalize the Central Bank.
The Fiscal Responsibility Law
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ECONOMIC AND SOCIAL STABILIZATION FUND
• Accumulates all of the surplus that exceeds 1%of GDP
FISCAL SURPLUS
CAPITALIZATION OF THE CENTRAL BANK
• 0.5% of GDP for 5 years
PENSION RESERVE FUND
• 0.2% of GDP minimum• 0.5% of GDP maximum