The fiscal rule has been one of the main assets of macroeconomic policy in Chile, providing a framework for fiscal policy action based on responsible management of public resources. Currently, the rule is one of the key components of Chile’s fiscal framework, and almost 20 years after it was introduced, its contribution to macroeconomic stability is clear.
The rule was abandoned with advent of the global financial crisis, which primarily resulted in the failure to meet the target for a longer period than had been expected. However, during the past 10 years, the efforts to restore the target and fine-tune the fiscal framework, including the rule, have brought to light a number of factors that merit far more comprehensive analysis, and, that, if improved, will enable fiscal policy to play its important role in the economy more effectively.
One of the most important roles of fiscal policy is to mitigate economic cycles, and accordingly, the rule is designed to perform this function. However, in practical terms, the estimation of the parameters that determine structural revenue entail problems that might cause fiscal policy to have the effect of accentuating economic cycles.
As we observe in Figure 1, the estimation of long-term economic growth has shown an upward bias in recent years that tends to be corrected negatively during the following year. In addition, as we observe in Figure 2, there has been a close correlation between long-term copper prices and the price for the immediately preceding year, and therefore both parameters add procyclicality to the calculation of structural revenue.
Real Copper Price
(2017 USD per pound)
Source: BML copper price deflated by US GDP deflator, according to BCCh, BEA, and OECD.Real Copper Price
(2017 USD per pound)
Source: BML copper price deflated by US GDP deflator, according to BCCh, BEA, and OECD.Real Copper Price
(2017 USD per pound)
Source: BML copper price deflated by US GDP deflator, according to BCCh, BEA, and OECD.There are also key factors not reflected in the rule that should be taken into account. One of these factors is the definition of a structural GDP growth rate that makes it possible to resolve the misalignments in the current account balance without impacting the exchange rate. Currently, as we observe in Figure 3, if the GDP gap in respect of trend performance is positive, the real exchange rate will appreciate persistently until the gap is less than zero. However, in terms of external equilibrium, long-term GDP will increase as the country becomes more competitive—a factor that should be reflected in the new rule.
Real Exchange Rate and Output Gap
Source: Central Bank of Chile and Budget Office.Real Exchange Rate and Output Gap
Source: Central Bank of Chile and Budget Office.Real Exchange Rate and Output Gap
Source: Central Bank of Chile and Budget Office.The rule is designed to safeguard the resources that belong to all Chileans, now and in the future. It is therefore also vital to understand that copper revenue is finite, and efforts should be made to ensure that it can also benefit future generations. A practical way to do so might be to emulate the approach that Norway has taken with great success in regard to the resources from its oil reserves. In simple terms, this involves using oil, a finite resource, to create a variable income fund to ensure profitability in the short term, for the country’s spending in the present, as well as resources to be used in the longer term once the utilized natural resources are no longer present.
The global financial crisis created a number of challenges for macroeconomic and fiscal policies, and almost 20 years after the fiscal rule was introduced in Chile, it is important to establish a new design for the fiscal framework that is more effectively adapted to new circumstances.
