Exchange Rates in Chile William R. Keech Carnegie Mellon University

Basics Economic –“Locus classicus” of inflation –But hyperinflation only with Allende –Currently “nil” Political –Democracy –Dictatorship –Democracy 1990-present

2 Episodes of rigid ER policy Last period of gold standard: –Hirschman: “misguided stubbornness” ER fixed at 39 to US dollar –Dornbusch and Edwards: “monstrously incompetent”

Crawling Peg First instituted under Frei Rate announced by Central Bank 3 exchange rates –Main rate for bulk of trade: forward bank rate –Rate for copper: spot bank rate –Tourism, etc: broker’s rate Purpose: more stability in RER

Unidad Popular: Focus on macroeconomic performance –1971 vs 1972 and 1973 –Massive public expenditure, debt, printing money Multiple exchange rates –Lowest 3 percent of highest –Big devaluations, but still < inflation

Crawling peg again: Dictatorship reduced govt. role in economy –Eliminated ISI; promoted trade But continued to control exchange rates –Reduced multiple rates to 3 and then 1 –Devaluation then revaluations –Fluctuating RER But inflation down to only mid 30s by 1979

Fixed ER: Inflation not falling Fixed ER 6/1979 to reduce inflationary expectations –39 peso to the US $ –RER appreciated by a third Inflation fell to 10% by 1982 But deep, deep recession

Abrupt devaluation Free float for a time Return to crawling peg

Since the 1980s Democracy bears fruits of market reforms –Keeping the neoliberal policies –Main economic change: Orientation to distributional issues Raising taxes to do it Inflation fell to single digits, while maintaining growth

Return to democracy, cont. Export success and inflow of capital –Led to appreciation in RER CB dealt with this “problem” but nominal rate remained at bottom of band 1992 revaluation and increase of band

Lessons Too much credibility? – and –But other (external) factors? Crawling peg seems to have provided a good combination of discretion and commitment Biggest lesson: get the fundamentals right

Questions Could Chile have gotten the fundamentals right under democratic institutions? Could the dictatorship have done it faster and at less cost than it did?