Monetary Policy in the US and Exchange Rate Management: The Chilean Experience and More José De Gregorio Vice Governor Central Bank of Chile May 18, 2007

2 In the context of inflation targeting monetary policy should be geared by inflation perspectives rather than developments in world monetary policy. Movements in world monetary policies affect emerging markets via growth prospects in the world and exchange rate fluctuations, but effects appear to be small given recent magnitude of interest rate changes. The high correlation is the result of correlation in inflation developments rather than follower-strategy. The case of Chile-US. Currently, the policy rate in Chile is below than that of the US. I. High Correlation of Monetary Policy Stance: Do emerging markets follow US monetary Policy?

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7 Is it possible to lean against the wind? Why Chile, a floater, has been one of the countries with the smallest appreciation and the largest terms of trade gain? Leaning against the wind may induce further capital inflows an pressures on the exchange rates. Non-credible interventions encourage inflows and loopholes on capital inflows generate large benefits to “loopholers” Interpretation of Levi-Yeyati and Sturzenegger (2007). Fear of revaluation (temporary) reduces real interest rate in dollars, it drives up capital inflows, relaxes liquidity constraints and generates a boom, not in export but in investment and perhaps mostly in non-tradables. But, what next? Openness - Terms of trade – real exchange rate – export performance and concentration. Which are the causal relationship? II. Exchange Rate Policies: Leaning Against the Wind and Floating?

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10 Real exchange rate Fuente: Banco Central de Chile. Nominal equivalentAverage Average

11 Exchange Rate Regime and International Borrowing Source: Cowan and De Gregorio (2005)

12 Policies that provide partial insurance on forex fluctuations inhibit foreign exchange market developments (hedges). The importance of the fiscal contribution. Although marginal effects may be limited (as those reported by Calderón and Perry), the existence of a fiscal framework may contain exchange rate pressures. Causality on concentration and real exchange rate: improvement in terms of trade rises value of current exportable goods (concentrated perhaps) and we will see a positive correlation between real exchange rate and concentration. Is the desirable a depreciation as result of a trems of trade decline?

13 Source: De Gregorio and Tokman (2004)

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15 Source: Central Bank of Chile

16 Lesson for policy: Latin American economies should try to move to floating in order to adjust to variable condition in the world. Lesson for interpretation of the evidence: growing with forex intervention is not necessarily sustainable not necessarily good. Lesson for research: perhaps we should move to case studies and ask under what conditions the transition from managed exchange rate to floating has been made. III. Concluding Remarks