Macroeconomic Policy and Economic Performance: Chile’s
Recent Experience
Luis F. Céspedes
Ministry of Finance-Chile
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?
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
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
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.
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.
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
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.
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.
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
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
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
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
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%
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
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
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
• 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
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