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?

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 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.

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 Chile

External conditions have been favorable for the Chilean economy in recent years Ene-00 Jul-00 Ene-01 Jul-01 Ene-02 Jul-02 Ene-03 Jul-03 Ene-04 Jul-04 Ene-05 Jul-05 Ene-06 Jul-06 Fuente: Cochilco

Fiscal Policy in Chile

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.

Fuente: Banco Central.

Gross Debt Public Sector (% of GDP) Source: Ministry of Finance

Portfolio management has also being consistent with keeping “competitiveness” of the economy

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