IDB shapes up for the future
Why has Chile been able to develop a successful economy while the rest of Latin America hasn’t?
After the crises we went through in the 1960s and 1970s, the country started to embrace fiscal responsibility. Second, we decided to open to trade. That process was initiated in the 1970s and continues today. We’ve also had very responsible governments [following the transition from Augusto Pinochet]. The past three administrations have built on Chile’s strengths rather than change everything.
Is it the economic model that other Latin American countries should follow?
It’s very difficult. Each country has to find its own model. Each country has to own its economic programme and decide how to implement it.
Is there a danger that Chile might fail to take advantage of the opportunity to become a fully developed country?
Given the success of the past 20 years, there is great ambition to go the extra mile. There is a consensus that we have strong foundations. We have three in particular. On the macro side we have strong public finances. The consolidated public debt of the central government and the central bank on a net basis is 5.7% of GDP – that’s nothing.
Second, we have an autonomous central bank that has a clear mandate, under the 1989 constitutional law, to keep price stability. The central bank has since built a reputation that it can deliver. In addition, we have a floating exchange-rate system; we haven’t intervened in the market for more than two-and-a-half years. We can intervene tomorrow if we think there is a big misalignment but it’s not our policy to be in the market [regularly]. So we have a well-functioning monetary framework.
Third, we have a strong banking system and deep capital markets. This is very important. Chile has a very low probability of a fiscal or financial system crisis. Another important element is that Chile is a very open economy. Today, the average import tariff is about 2%.
A presidential election will take place in December. All the candidates have said that they will dilute the fiscal stabilization fund surplus from 1% to 0%. Is this a concern?
There is a lot of awareness of keeping fiscal responsibility. Each of them has to define what they mean by that. In this country, there is a very low probability that we will go to populism on the fiscal side, especially now with the rule in place.
On monetary policy, are you looking for a neutral level in your interest rate policy and, if so, how do you define neutral?
We have a forward-looking monetary policy. We try to anticipate where inflation will go in the next 12 to 36 months. So, if we think there is a high probability that inflation will miss our target of between 2% and 4% for a sustained period of time, then we will move rates.
We have announced that the rate we have today is not compatible with price stability as we define it: inflation of about 3%. We are very explicit that the board considers current monetary policy is very expansionary and we are in a process of normalizing it. We don’t know when we’re going to stop.
We know that the rate today is much below any neutral level but we don’t know what is the neutral level because things have changed not only in Chile but also in the world’s financial markets. Maybe the neutral rate is much lower than it used to be, but we don’t know. We are carrying out research and we will use our judgement.
Is inflation-targeting a durable policy?
It’s in place until we discover something that will be better. We have used many mechanisms before. We tried to achieve low inflation via a fixed exchange rate. It was a disaster twice, in the late 1950s and late 1970s.
Another method that has been used by some countries has been to target monetary aggregates. But that is not a good instrument to control inflation for the short to medium term. It’s a very good instrument for the long run. But to gain credibility for achieving price stability you need an instrument that is much more geared towards [controlling] inflation in the short to medium run. Most countries in the world have abandoned the use of monetary aggregate [policy] to target inflation.
Isn’t the problem with inflation-targeting that everything is geared towards keeping inflation within a certain band, potentially at the expense of other things, such as growth?
We are not inflation nuts. We are not trying to keep inflation at 3% next month or within two months. We have a 12-month to 36-month horizon. We address the fact that there is a trade-off, in the short run, between inflation and unemployment, and inflation and an output gap.
We don’t think there is a trade-off in the long run. Given this, the best thing to have is low inflation because that has many benefits in terms of improving efficiency and the use of resources. Low inflation is also associated with low volatility in relative prices. So we are very concerned about output, but the way we accommodate it is by the fact that we try not to have an inflation rate of 3% every day – we have a range.
What impact will volatile commodity prices have on monetary policy?
That creates some noise regarding inflation. Chile has a very wise policy that the price of energy and petrol is adjusted every week at international market values. So prices move a lot, which provides a lot of noise to the monthly CPI. But we are getting used to using core inflation (as opposed to headline inflation), which is a better indicator of where inflation is going in the next 12 to 36 months. Headline inflation today is at 2.7% on a 12-month basis, while core inflation is at 2.4%.