A. Introduction

5. Chile has experienced very strong growth in the last decade, but copper continues to have a major role in the economy. The purpose of this paper is to examine the dynamic relationships between the copper price cycle, the Chilean business cycle, and the various GDP components in the country’s economy.²

6. The Chilean economy is very dependent on copper according to several measures. In terms of exports, copper accounted for 42 percent in 1997, while the mining sector, which includes other minerals, accounted for 50 percent. In terms of GDP, the mining sector accounted for 8 percent in 1997.³ In terms of fiscal revenues, CODELCO, which is the state company that manages the public copper mines (see Box 2), contributed 3.6 percentage points of GDP in 1997, representing more than 10 percent of the central government’s revenues.⁴

7. While such a high dependency on a natural resource is common to other countries, a singular characteristic of Chile is that both the mining sector and the rest of the economy have grown at roughly the same pace over the last decade, even though Chile’s GDP has grown at an average annual rate of 8 percent during that period.⁵ This fact is surprising given the slightly different reasons behind growth of the mining sector and that in the rest of the Chilean economy. The mining sector grew because of the rapid expansion of production (an increment of more than 130 percent from 1988 to 1997) due to massive capital inflows, while the other sectors of the economy expanded in response to profound structural reforms and a stable macroeconomic environment.

8. The massive investment in the copper sector of recent years, and the large reserves of copper (28 percent of the world’s proven and economically viable reserves are in Chile) indicate that copper will remain very important in the Chilean economy in the future. This has prompted a debate on several aspects of copper exploitation. This paper focuses on the positive aspects of the behavior of the Chilean economy in relation to copper. Other aspects, such as the optimal policies in the exploitation of natural resources, are not considered here even though they may be very important.

Box 1.

Copper

Copper is an important input in a wide range of industries due to its thermal and electrical conductivity. It is used in the construction industry as wire and tubing for plumbing and air conditioning, in manufacturing to build electronic equipment and in the automotive industry for electrical equipment, and in telecommunications to build copper cables.

Almost half of the world’s known reserves of copper are concentrated in two countries (Table 1): Chile accounts for 28 percent of the reserves, while the United States accounts for 17 percent. Other individual countries have considerably fewer reserves. The distribution of copper production is even more concentrated, with Chile producing 34 percent of the world output, and United States 17 percent.

Table 1.

World Copper Reserves

(In millions of metric tons)

Source: U.S. Geological Survey, Mineral Commodities Summaries (January 1998).

^1/Basic reserves include all known reserves.

^2/Reserves include only reserves which are economically viable.

Table 1.

World Copper Reserves

(In millions of metric tons)

Country	Basic Reserves 1/	Percent of total reserves	Reserves 2/	Percent of total reserves
Chile	163.0	25.9	88.0	27.5
United States	90.0	14.3	45.0	17.0
China	37.0	5.9	18.0	5.6
Poland	36.0	5.7	20.0	6.3
Zambia	34.0	5.4	12.0	3.8
Russia	30.0	4.8	20.0	6.3
Congo (Kinshasa)	30.0	4.8	10.0	3.1
Mexico	27.0	4.3	15.0	4.7
Peru	24.0	3.8	7.0	2.2
Canada	23.0	3.7	10.0	3.1
Australia	23.0	3.7	7.0	5.1
Other Countries	113.0	17.9	68.0	21.3
Total	630.0	100.0	320.0	100.0

Source: U.S. Geological Survey, Mineral Commodities Summaries (January 1998).

^1/Basic reserves include all known reserves.

^2/Reserves include only reserves which are economically viable.

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Table 1.

World Copper Reserves

(In millions of metric tons)

Country	Basic Reserves 1/	Percent of total reserves	Reserves 2/	Percent of total reserves
Chile	163.0	25.9	88.0	27.5
United States	90.0	14.3	45.0	17.0
China	37.0	5.9	18.0	5.6
Poland	36.0	5.7	20.0	6.3
Zambia	34.0	5.4	12.0	3.8
Russia	30.0	4.8	20.0	6.3
Congo (Kinshasa)	30.0	4.8	10.0	3.1
Mexico	27.0	4.3	15.0	4.7
Peru	24.0	3.8	7.0	2.2
Canada	23.0	3.7	10.0	3.1
Australia	23.0	3.7	7.0	5.1
Other Countries	113.0	17.9	68.0	21.3
Total	630.0	100.0	320.0	100.0

Source: U.S. Geological Survey, Mineral Commodities Summaries (January 1998).

^1/Basic reserves include all known reserves.

^2/Reserves include only reserves which are economically viable.

World demand for copper presents wide regional variation over time (Table 3). Despite declining shares, North America and Western Europe remain the biggest users of copper with a combined share of 59 percent of world demand. Given the extensive use of copper in the construction, light automotive, and telecommunication industries, an increasing share of copper is used in newly industrialized economies. Asia, excluding Japan, increased its world share in consumption of copper from 20 percent in 1992 to 25 percent in 1997, making the region the most dynamic market for copper.

Table 3.

Copper Consumption by Countries or Regions

(Percentage of the World consumption)

Source: World Metal Statistics (various issues).

Table 3.

Copper Consumption by Countries or Regions

(Percentage of the World consumption)

	1992	1993	1994	1995	1996	1997	1998
Europe						1
Germany	10	8	9	9	8	8	9
France	5	4	4	4	4	4	5
Italy	5	4	4	4	4	4	4
UK	3	3	3	3	3	3	3
Other Europe	16	14	13	13	12	12	13
Africa	1	1	1	1	1	1	1
Asia
Japan	13	13	12	12	12	11	10
China	8	9	7	9	9	9	8
Taiwan	4	4	5	5	4	4	4
South Korea	3	4	4	4	5	5	4
Other Asia	6	7	7	7	8	9	9
America
U.S.A.	20	21	23	21	21	21	22
Canada	1	2	2	2	2	2	2
Mexico	1	2	2	1	2	2	2
Other America	3	3	3	3	3	3	3
Oceania	1	1	1	1	2	1	1

Source: World Metal Statistics (various issues).

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Table 3.

Copper Consumption by Countries or Regions

(Percentage of the World consumption)

	1992	1993	1994	1995	1996	1997	1998
Europe						1
Germany	10	8	9	9	8	8	9
France	5	4	4	4	4	4	5
Italy	5	4	4	4	4	4	4
UK	3	3	3	3	3	3	3
Other Europe	16	14	13	13	12	12	13
Africa	1	1	1	1	1	1	1
Asia
Japan	13	13	12	12	12	11	10
China	8	9	7	9	9	9	8
Taiwan	4	4	5	5	4	4	4
South Korea	3	4	4	4	5	5	4
Other Asia	6	7	7	7	8	9	9
America
U.S.A.	20	21	23	21	21	21	22
Canada	1	2	2	2	2	2	2
Mexico	1	2	2	1	2	2	2
Other America	3	3	3	3	3	3	3
Oceania	1	1	1	1	2	1	1

Source: World Metal Statistics (various issues).

The price of copper is quite volatile because demand and supply are not very sensitive to price changes in the short run. Additionally, Borensztein, et al. (1994) report that commodity prices have become more volatile over the last decade. Formal tests show that the hypothesis of unit root cannot be rejected even with large critical values.

The long-term prospects for copper production are good. Copper’s particular physical characteristics, make it appealing in a wide range of applications, and the substitution of new materials unlikely, although the metal faces increasing competition from optic fibers in the telecommunication industry, and from aluminum in the construction and automotive industries.

9 The paper is divided into five sections: the first section contains a brief review of the literature on copper and the Chilean economy, the second section presents some stylized facts on the links between copper and the Chilean business cycles, focusing on the short run, the third section analyzes the long-run relationships between copper exports and macroeconomic variables, the fourth section discusses some possible transmission mechanisms, the fifth section draws some policy conclusions and is followed by a technical appendix.

B. Literature Review

10. In addition to the vast literature on natural resources and growth, there are some specific studies on copper and Chilean economic policy that consider both long-term and business cycle issues. Papers that focus on the long-term effects of copper include: Morandé and Quiroz (1996), Bande and French-Davis (1989), Romaguera and Contreras (1995), and Moguillansky (1998). Papers that focus on copper and cyclical issues include Calvo and Mendoza (1998).

11. Morandé and Quiroz (1996) consider the long-term effects of the mining sector on the real exchange rate, wages, and fiscal revenues. By analyzing the experience of the early 1990s, they conclude that copper has had a modest effect on the real appreciation of the exchange rate and wages, but negligible effects on inflation. Furthermore, they notice that the mining industry is capital-intensive and that capital is largely imported, so that local resources are not displaced and the possibility of a Dutch disease is very small. Additionally, copper brings considerable resources to Chile’s Treasury. The authors conclude that copper is a “full-blessing” and that any “significant intervention by government authorities to try to counterbalance the small negative effects in some sectors would likely bring harmful side effects.”

12. Bande and French-Davis (1989) find that copper contributed to the downturns of late 1974 and 1981, while the price upturn of 1987-89 was a determinant for the sharp recovery that took place in that period. They notice that the main objective of public policies on copper between 1973 and 1988 was to expand production and to set up appropriate mechanisms to offset the economy’s external vulnerability. They argue that, while the first objective was partially met, the second objective has not been reached because “of the excessive reliance on the market mechanisms to counteract fluctuations of the copper price.”

13. Romaguera and Contreras (1995) study the impact of copper in the context of structuralist analysis and conclude that the copper price cycle has had an important effect on Chilean growth in the last 40 years by determining the external and fiscal constraints. They also argue that the huge fluctuations of copper prices have made fiscal revenues and the availability of foreign currency very unstable and have had negative consequences on growth in the long run.

14. Moguillansky (1998) focuses on investment in the mining sector. She argues that the institutional framework (the law on foreign investment (1974) and the law on mining (1980)) created the necessary conditions for the increase of copper production in the early 1990s. She also finds evidence that foreign investment in the copper sector has had a positive effect on CODELCO, which invested heavily in the beginning of the 1990s to maintain efficiency.

15. Calvo and Mendoza (1998) study the effects of copper on Chilean business cycles in the period 1986 to 1997. They find that the lagged core terms of trade, which are defined as the ratio between the price of copper over the price of oil, Granger-cause IMACEC, which is a monthly indicator of economic activity. Additionally, they find that “after two years about one quarter of the variability in the growth of IMACEC is attributable to the core terms of trade.” The authors also present evidence that “changes in the exchange rate and in the performance of the external sector help explain the decline in inflation.”

16. Although the papers reviewed use different frameworks (neoclassical or structuralist), different methodologies (time series analysis and case studies), and different periods of analysis, they all reach the conclusion that copper has played a crucial role in the Chilean economy.

C. Short-Run Perspective: Copper Price Cycle and the Chilean Business Cycle

17. This section presents evidence on the connection between the copper price cycle and the Chilean business cycle. In the first part, the behavior of Chile’s GDP is examined and its main components are compared with the copper price cycles; in the second part, some price variables (such as wages, exchange rates, price of shares) are considered and compared with the copper price cycles. The focus is on the behavior of the economy during the copper cycles, and highlights the peculiarities of each cycle.

18. Figure 1 shows the evolution of the (log) real price of copper in the last 40 years.⁶ Copper prices show a negative trend that started in the mid-1960s and lasted until the mid-1980s. Around this trend, copper prices have shown dramatic variability which is typical of a natural resource for which both demand and supply are inelastic to price changes in the short run. Variations around the trends are the focus of this section. The long-term negative trend is discussed in Section D.

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Chile: Real Copper Price

(In logs)

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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19. The short-term analysis focuses on the period after 1986 because official quarterly data on national accounts are available only after 1986, there are relatively few economic structural breaks in this period, and the price of copper does not have a clear trend after 1986. The absence of a trend allows us to focus on short-term fluctuations without worrying about secular movements. Since 1986, copper has had three clear cycles, which peaked in 1989:Q1, 1995:Q3, and 1997.Q3. Over the last decade, the frequency of the cycles seems to have increased, while the period between peaks and troughs has diminished. During the first cycle, the price of copper more than doubled in two years, and then halved to its original level in the following four years; during the second cycle, the copper price rose by 60 percent in seven quarters, and halved in one year; in the last cycle it rose by 40 percent in one year, to go back to its original level in less than one year. Figure 2 shows the behavior of the log of the real copper price during the three cycles, and a summary line showing the “average cycle.” The lines are centered with the respect to the horizontal axis so that the peaks of the cycles (1989.Q1, 1995.Q3, and 1997.Q3) correspond to zero.

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Chile: Distance from Copper Price Peak

(In real copper price)

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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20. Figure 3 shows the strong correlation that exists between fourth-quarter GDP growth and the real price of copper.⁷ In all three copper price cycles, GDP growth peaked one or two quarters after the copper price peaked. The expansion starting in 1990:3 and peaking in 1992:3 was the only recent Chilean business cycle that was not anticipated by the copper price cycle. However, this business cycle is atypical both for internal and external reasons. Internally, there was the transition from the military regime to a democratic government. Externally, the expansion corresponded to the wave of capital flows to emerging markets. Schadler, Carkovic, Bennett, and Kahn (1993) explain that countries that received large capital inflows in the early 1990s experienced an economic boom, although the surge in economic activity in Chile took place with some lag. In addition, Moguillansky (1998) reports that there was considerable investment in the mining sector in the early 1990s following the previous price boom of the late 1980s. The analysis here concentrates on the three business cycles that are directly correlated with the copper price cycles.

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Chile: Four-quarter GDP Growth and Real Copper Price

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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21. Figure 4a shows the four-quarter real GDP growth in the three episodes under consideration. While in the first two cycles economic activity accelerated rapidly as the copper price increased, the last cycle is atypical because economic activity did not increase very fast during the expansionary phase. All three cycles share a sharp decline in the rate of growth of real GDP starting one or two quarters after the peak of the copper price.

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Chile: GDP Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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22. Before analyzing the behavior of the GDP components, it is useful to clarify two issues. First, the strong relationship between GDP growth and the copper price cycle could reflect the impact of copper prices on copper output since mining, which is mostly copper, accounts for about 10 percent of Chile’s GDP. To examine this issue, industrial production is used as an indicator of economic activity which does not include the copper sector directly; Figure 4b shows the 4-quarter growth of industrial production during the copper cycles. Also, in this case, there is a strong correlation between the copper cycle and the cycle of economic activity. So it can be concluded that the relationship between copper cycles and GDP growth is not merely a reflection of the evolution of the mining sector. Second, it is important to clarify how a short-run shock in the copper sector is identified; the alternatives are price changes and revenue changes. This analysis uses prices because they are largely out of Chile’s control in the short run. In fact, the growth of copper production does not change significantly over the copper cycle (Figure 4c), reflecting the fact that it is difficult to increase production in the short term. This allows us to focus on prices in the short-run analysis, rather than on export revenues, which is appropriate for long-run analysis when supply is responsive to price.

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Chile: Industrial Production Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Change in Copper Production Four-quarter

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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23. Figures 5 to 8 show the behavior of the domestic components of GDP through the three copper price cycles. All percentage changes are with respect to the same quarter of the previous year. Even though all components of GDP are procyclical, the different components show different patterns around the cycle. Private consumption tends to be smoother and to lag so that the peak in consumption is on average two quarters after the peak in the copper price. Even though private consumption is smoother than the other components of aggregate demand, its variability is quite remarkable and is difficult to reconcile with standard models of aggregate consumption behavior. The excess volatility of consumption could be explained by liquidity constraints, which are eased during periods of high copper prices.⁸

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Chile: Consumption Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Fixed Investment Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Fixed investment In Machinery Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Fixed investment in Construction Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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24. Investment is more sensitive to the cycle, and in all cases peaks one quarter after the copper price peaks. On average, fixed investment grew by more than 30 percent on a four-quarter basis at the peak of the cycle. Given the importance of investment for the subsequent analysis, fixed investment is divided into two components: machinery and construction (Figures 7 and 8).⁹ Taken singularly both components show an even more remarkable similarity across cycles than aggregate investment. In particular, the investment in machinery, which is mostly imported, surged virtually at the same rate in both cases for which the data are available.

25. The foreign components of GDP and the aggregate GDP changes behave differently in relation to changes in copper prices. Imports, which are highly correlated to investment and consumption of durable goods, show a pattern similar to investment. Figure 9 shows that imports surged in tandem with every cycle and peaked one or two quarters after the peak in the price of copper. Figure 10 shows no clear pattern for the four-quarter growth of exports.¹⁰ This is not surprising given that copper output is not responsive to copper price changes in the short run, while other exports are not influenced by the mining sector and could be damaged by the appreciation of the real exchange rate.

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Chile: Import Four-quarter Growth.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Export Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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26. The behavior of the trade balance is ambiguous in principle because it depends on revenue from copper exports, on other exports (which are hurt by the appreciations accompanying a higher price of copper), and on imports (which surge during a copper price boom). Figure 11 shows no marked pattern of the trade balance across copper cycles.¹¹ However, the trade balance seems to be stable during the copper boom, while worsening significantly after the copper price peak by an average of two GDP percentage points. Figure 12, which analyzes four-quarter differences in the trade balance, also shows a progressive worsening of the trade balance starting one quarter before the peak.

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Chile: Trade Balance

(Moving average of GDP share) Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Four-quarter Difference in Trade Balance.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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27. The current account as a share of GDP does not present a clear pattern over the three cyclical episodes (Figure 13). Figure 14 shows the capital account as a share of GDP; as the copper price increases, there is a surge of capital inflow which is largely due to the increase of foreign direct investment (Figure 15). This observation matches the observation that there is a surge in investment during the first phase of a copper boom; Figure 15 shows that foreign direct investment has played an important role in financing these surges. Copper booms spur an investment boom in the mining sector, especially after the mining law of 1980 (see Moguillansky, 1998) which provided the legal framework for foreign investment in the mining sector. Since the quarterly data in the analysis start in 1986, the full effect of the investment booms are observed to correspond with the copper booms.

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Chile: Current Account

(Share of GDP in US$) Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Capital Account

(Share of GDP in US$) Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: FDI Four-quarter Growth

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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28. The effects of copper cycles on the exchange rate are quite strong. Figure 16 shows that the changes in the nominal exchange rate are strictly correlated with the copper cycle.¹² In all three cases, the nominal exchange rate appreciates (or depreciates less) during the copper boom and depreciates (or appreciates less) as the price of copper declines. On average, the turning point corresponds to the peak in the price of copper and precedes but one or two quarters the peak of the business cycle. Figure 17 shows the behavior of the real exchange rate during the copper cycles.¹³ In all cases, there is a strong appreciation. On average, the real exchange rate appreciated by 8 percent with respect to the peak of the business cycle of the previous year.

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Chile: Four-quarter Nominal Exchange Rate Percentage Growth.

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Real Exchange Rate Four-quarter Growth.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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29. The behavior of the nominal and real exchange rates during the cycles shows that the early phase of the copper cycle is characterized by an increase in foreign currency inflows due both to the direct effect of copper revenues and the indirect effect of the increase in foreign investment. Both factors put upward pressure on the exchange rate which in all cases appreciate until the peak of the copper price cycle. When the copper price declines, the upward pressure fades out and the appreciation of the real exchange rate slows until it stabilizes about one year after the peak of the cycle.

30. The behavior of the exchange rate has some effect on the inflation rate. Figure 18 shows the behavior of inflation during the copper cycle. During the first phase of the copper cycle, when the real exchange rate is rapidly appreciating, inflation declines in all three episodes. During the second phase, when the copper price falls and the rate of appreciation declines, inflation stops declining in two episodes and increases abruptly in the 1989:Q3 episode. In conclusion, there is an asymmetry in the relationship between inflation and copper price changes: while inflation always goes down as the price of copper increases, inflation does not go up as the price of copper decreases. This asymmetric behavior of inflation with respect to the business cycle can reflect an asymmetric response of the monetary authorities to the copper cycle as is elaborated below.

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Chile: Four-quarter Inflation.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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31. Figure 19 shows the real lending rate in the three episodes.¹⁴ While during the last two copper cycles there is no clear pattern, there is an interesting behavior in the first cycle. During the first phase of the cycle, in the presence of strong capital inflows, the lending rates are quite low, while in the second phase the real lending rates rise. The behavior of the interest rates may also reflect to some extent the policy response of the central bank to a weakening of the current account. During the second phase of the copper price cycle, when the copper price declines, the current account deteriorates, the peso tends to depreciate, and inflation to increase, and monetary policy tends to tighten. This interpretation of events is of course very tentative, as it is based on the three copper cycles under review and cannot be formally tested. Nevertheless, this interpretation would be consistent with official statements indicating that reducing external imbalances has been an important concern of monetary policy during the 1990s.

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Chile: Real Lending Rate.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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32. The behavior of share prices (Figure 20) shows some pattern as shares always peak together with the copper cycle or after one quarter later. This pattern probably reflects the behavior of the interest rate and the external sector and is only indirectly influenced by copper. The pattern of real wages is more clear (Figure 21). Real wages have had an upward trend during the period considered, but their rate of growth rises as the price of copper increases. This could reflect an increase in nominal wages, and the slowing down of inflation in the presence of backward-looking indexation. Jadresic (1997) finds evidence that “Chilean private aggregate wages during the 1980s are well described by two-year contracts that are revised every six months according to 100 percent of past inflation.” Whatever the reason for the increase in the rate of growth at the beginning of the copper cycle, real wages typically slow down after the peak of copper cycles. Rising real wages could explain the increase in private consumption that is observed one or two quarters after the copper cycle peak.

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Chile: Share Price Four-quarter Growth.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Real Wages Four-quarter Growth.

Distance from copper price peak

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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33. Overall, the analysis of the last three copper cycles has shown that all three copper cycles anticipated the Chilean business cycle by one or two quarters. Moreover, all GDP components behaved similarly in the three episodes. In particular, investment, which has a high component of imports and foreign financing, seems to be particularly sensitive to the copper cycle. Copper cycles, either directly or indirectly though policy responses, have been associated with real exchange rate appreciation and disinflation.

D. Long-Run Perspective: Copper Trends and the Chilean Economy

34. This section analyzes the long-run effect of copper on the Chilean economy. While in the previous section the focus was on the business cycle using quarterly data, this section focuses on annual data from the beginning of the 1960s to 1997 to study the statistical relationship between developments in the copper sector and the Chilean economy. Moreover, the unit of analysis in this section is real copper export revenues, not prices, given that in the long run the copper supply is elastic. Finally, the log difference of real copper export revenues (LRCOEX) is taken in order to have a stationary explanatory variable.

35. As in the previous section, we first look at the general relationship between copper exports and the Chilean economy. Regression 1 shows how LRCOEX anticipates changes in real GDP growth. The short-term effect (annual effect) is simply the coefficient on LRCOEX, while the long-term effect takes into account the lags of the dependent variable.¹⁵ The elasticity of GDP growth to real copper revenues growth is 0.1 in the same year and 0.19 in the long run, meaning that an increase in real copper revenue growth of 10 percent increases GDP growth by 1 percent in the short run and by 1.9 in the long run. The short-term response could be due to the fact that the mining sector accounts for about 10 percent of GDP, so that a 1 percent increase in mining output means that GDP grows by 0.1 percent. However, in the long run the elasticity doubles, showing that the copper sector has a strong multiplier effect, which almost doubles its short-term impact. This result is quite robust to the time period and the specification chosen.

36. The result that LRCOEX has an effect on GDP growth both in the short- and long-term periods is complementary to the finding of the previous section that copper cycles have preceded Chilean business cycles in the last decade. Not only has copper determined fluctuations around a long-term trend, but it has also influenced this trend. Generally, the factors that determine long-term growth (such as productivity and factor accumulation) are different from the factors that determine fluctuations around the trend (such as aggregate demand), so the channels through which copper influences the Chilean economy could be different in the long and short runs. The rest of this section examines the channels through which copper influences the Chilean economy in the long run and contrasts them with the analogous channels in the short run.

37. LRCOEX does not have an influence on private consumption growth in the long run (see Regression 3 in the technical appendix). This result and our previous finding that private consumption is sensitive to the copper cycle in the short run show that copper has only a short-term effect on consumption.

38. LRCOEX has an influence on investment growth in the long run (see Regression 4 in the technical appendix). While a 10 percent increase of the rate of growth of copper exports has only a moderate immediate effect on investment, it increases real investment growth by 93 percent in the long run. This matches the finding of the previous section, in particular, the high volatility of investment growth and its strong correlation with the copper cycle.

39. Another way of looking at the effect of copper on the components of GDP is to look at income shares. Regression 5 shows that a 10 percent increase of real copper export growth does not have any effect on the investment share in the short run, but it increases the investment share by 6.6 percentage points in the long run. Since investment has an upward trend, part of this increase could be spuriously attributed to copper. However, Regression 6, which controls for a time trend, confirms the results although the size of the effect is smaller than before: a 10 percent increase in real copper export growth increases the investment share only by 1.7 percentage points in the long run. This finding confirms the results on the business cycle of the previous section.

40. Regression 7 shows that real copper export growth has little effect on the import share in the short run, but a large effect in the long run.¹⁶ In the short run, the effect of copper on the import share is negative and not very robust. In the long run, a 10 percent increase in the growth of copper revenues increases the import share by 5.1 percentage points. If the sample is restricted to the years after 1975 to avoid clear structural breaks, this coefficient is much smaller.

41. Regression 8 provides an alternative way of looking at the effect of copper on imports by using the share of copper exports in GDP as the independent variable. In the short run, the copper export share is not correlated with import share. But, in the long run, each additional percentage point of copper exports increases imports by 0.7 percentage points. If the sample is restricted from 1975 onwards, the long-run import response decreases to 0.3 percentage points. These results merit two observations. First, they are consistent with the previous findings that an increase in copper exports translates into an investment boom which, in turn, increases imports. Second, the analysis is limited to partial equilibrium. In particular, higher investment in the mining sector means higher capacity, and so higher exports in the future. For this reason, it is not correct to say that in the long run one percentage point of higher copper revenues improves the current account only by 0.3 percentage points because this does not take into account all the secondary effects such as higher investment, or the effects on the real exchange rate.

42. In Regressions 9 to 13, the long-run fiscal position is examined. In order to have a consistent measure over the entire period, the surplus of the central government as a share of GDP is used. An increase of real copper export growth by 10 percent improves the fiscal surplus by 0.27 percentage points in the short run, and by 1.62 percentage points in the long run. Even if the results go in the right direction and have plausible magnitudes, they are estimated imprecisely; this is because there were important structural breaks in the relation between copper and fiscal behavior in the 1970s. If the sample is restricted to the first 13 years, 1963-1975 (Regression 10), the relationship between copper export growth and the fiscal position becomes stronger (a 10 percent increase of copper revenue growth improves the fiscal position by 3.3 percentage points in the long run) and is measured more precisely. Conversely, taking the last 21 observations, 1976-96 (Regression 11), a 10 percent increase of copper export growth is found to improve the budget only by 1.2 percentage points in the long run. These results should be taken only as an indication of a trend, given that they are based on a partial equilibrium analysis and on a limited number of observations. Nevertheless, the finding that the role of copper in public finances has been diminishing over time may reflect the introduction of the copper stabilization fund, and the increased importance of other sources of revenues.

43. Regression 12 considers the effect of copper export revenues, expressed as a share of GDP, on the position of the central government. An additional GDP percentage point of copper exports improves the central government position by 0.5 percentage points in the short run, while the improvement rises to 0.78 percentage points in the long run. As before, the reader is cautioned that this analysis is based on a partial equilibrium and does not take into account second-order effects.

44. The fiscal position is strongly linked to the business cycle, which in turn is associated with the copper price cycle. Regressions 9 to 12 considered the total effects of copper on the fiscal position, including not only additional revenues accruing to the central government as a result of higher copper exports but also the higher tax revenues coming from stronger economic activity. In Regression 13, controls for the second effect by introducing GDP growth. When controlling for the business cycle, the effects of copper export growth are similar and still significant. In the long run, a 10 percent increase of copper export growth improves the fiscal position by 1.6 percentage points.

45. Overall, the analysis of the annual data between 1963 and 1997 suggests that copper exports have a significant effect on long run growth, especially through investment. The increase in investment in turn explains higher imports. Private consumption growth seems not to be affected by copper, while the fiscal position improves significantly as copper revenues increase. The effect on the fiscal position has become less relevant in the last decade, reflecting structural changes that have diminished the dependency and sensitivity of the fiscal accounts with respect to copper.

46. As the previous analysis is based on regressions with a limited number of observations, it also precluded the use of many control variables. For this reason, the analysis was limited to a partial equilibrium analysis and the results must be considered with care.

E. Transmission Channels

47. In the previous sections, it was established that the copper cycles have strong implications for the Chilean economy both in the short and the long runs. This section takes an alternative approach by looking separately at different possible transmission mechanisms and checking whether they are compatible with the stylized facts outlined in the previous sections.

Private consumption—wealth effect

48. A higher price of copper increases the national wealth of Chile. This could happen either directly if Chilean nationals own copper mines, or indirectly through a Ricardian equivalence if the government owns the copper mines and nationals anticipate fewer taxes in the future. In both cases, the private sector should increase consumption in response to a higher copper price. This effect should be particularly noticeable in the long run because the private sector would lag by several periods before updating its long-term consumption path.¹⁷ Regression 3 shows that there is no evidence of changes in consumption growth due to changes in copper export growth so a simple wealth effect mechanism can be ruled out. There are several possible reasons why the wealth effect does not play a major role: a failure of the Ricardian equivalence, credit constraints, perception that the innovations in the price of copper are not permanent, and the fact that large part of the mines in Chile are now foreign-owned.

Private consumption—higher wages

49. Many studies have shown that the wages of an industry are influenced by the profitability of that industry, and is probably the case for the mining industry in Chile, so a higher copper price should push higher wages for the mining workers. Eventually, the wage increase should spread to workers in other sectors. However, this hypothesis is not very appealing because workers in the mining sector are not numerous, and are concentrated in a few regions. For these reasons, the labor market is fragmented and it is difficult to imagine the mining sector as a wage setter for the other sectors. Nevertheless, real wages have increased more as the price of copper has risen. This could be due to the fact that inflation is negatively correlated with the price of copper, which, in the presence of backward-looking indexation, leads to an increase in real wages. Additionally, the public sector, which has more resources during copper booms, could give higher nominal wage increases.

Investment component—mining sector

50. If the innovations in the price of copper are (or are perceived) as permanent, higher prices will bring new investment to the mining sector. There is strong evidence of this channel. Both short-term (Figures 7 and 8) and long-term evidence (Regression 4) show that investment is quite sensitive to the price of copper. Since the late 1980s and early 1990s (Moguillansky, 1998), foreign direct investment has been concentrated in the mining sector so that there has been a strong link between the copper cycle and foreign direct investment. Moreover, the cycle starting in 1990:3 and peaking in 1992:3, which was the only recent Chilean business cycle not anticipated by the copper cycle, was characterized by a surge in foreign investment mainly in the copper sector. The drawback of the high responsiveness of investment to the business cycle has been the increase in imports that accompanies every copper cycle.

Capital inflows—perceived stability

51. During the 1990s, Chile has followed prudent economic policies which have created a favorable framework for long-term economic growth. It is difficult to evaluate how the high copper prices have contributed to this favorable scenario. The high price of a commodity is not an automatic blessing. In fact, there are many countries for which a natural resource is a mixed blessing that leads more to rent-seeking behavior than to sound investment and development. Keeping this is mind, it is fair to say that copper export revenues, which have been wisely administered, have favored Chile’s economic stability in the long run.

Investment—through monetary authority response

52. Since the beginning of the 1990s the central bank of Chile has been concerned not only with internal inflation but also with external stability, trying to limit the size of the current account deficits. During the first phase of a copper cycle, the tendency is for the current account position to improve, the exchange rate to appreciate, and inflation to diminish, thus monetary policy can be more expansive. During the second phase, however, when the price of copper declines, the current account tends to worsen, the exchange rate tends to depreciate, and inflation does not go down, monetary policy is more restrictive. The pattern of the real lending rate during the copper cycles is compatible with this hypothesis.

Fiscal component

53. CODELCO gives all of its profits under various forms to the treasury. The higher copper price can thus increase public revenues and make the budget constraint less stringent. The analysis here shows that this has happened even though this channel has probably worked more effectively in the past. In the last ten years, new institutional innovations such as the copper fund and the increased importance of alternative forms of financing, have progressively limited the importance of copper in public financing.

F. Conclusions

54. This paper has examined how the Chilean economy has responded to the copper cycle both in the long run and the short run. Tailoring the analysis to the availability of data (annual data between 1960 and 1997 and quarterly data between 1986 and 1998), statistical analysis was used for the long run, and graphic and case-by-case analysis for the short run. The two kinds of analysis are complementary since short-term and long-term adjustments are potentially different.

55. The main conclusion of the analysis is that copper prices are important for short-term fluctuations and probably have an influence on long term growth. While many mechanisms can be at work, investment seems to play a major role. During periods of high copper prices, both internal and external factors favor investment. Internally, lower current account deficits probably lead to less stringent monetary policy. Externally, international investors are attracted by the high copper price and by the enhanced long-term external stability. Additionally, the high copper price and capital inflows have typically created upward pressure on the real exchange rate in the first phase of the copper cycles. The rapid appreciation and increased demand for investment goods have, however, partially offset the positive effects of copper on the current account.

56. The appreciation of the Chilean peso during the first part of the copper cycle has also favored the policy of progressive disinflation pursued by the central bank of Chile. Typically, the fastest gains in the disinflation policy have been obtained when the copper price was increasing, while the central bank has consolidated the gains in disinflation during periods of a decreasing copper price. In the presence of backward-looking indexation, this also may explain how real wages have grown more rapidly during the phase of increasing copper prices.

57. Unlike other countries endowed with natural resources, there is only limited evidence of consumption booms induced by the copper cycle in the short run. In the short run, part of the increase in consumption could be indirectly due to the higher real wages and decreasing inflation at the beginning of the copper cycle. Moreover, there is little evidence of share booms during the cycles probably because foreign capital has not been invested through the stock market. Copper cycles have also been very relevant for the fiscal balance, even though their importance has been decreasing thanks to the development of alternative sources of revenue and the introduction of the copper stabilization fund.

58. This paper has described the stylized facts about the correlation between the Chilean economy and the copper cycle. Copper has played an important role in the Chilean economy but the reasons for Chile’s success in the last decade are much more complex and go beyond the development in the copper sector. The endowment of a natural resource is no substitute for competent micro and macro economic management.

Table 2.

World Copper Production by Countries or Regions

(Percentage of world production)

Source: World Metal Statistics (various issues).

Table 2.

World Copper Production by Countries or Regions

(Percentage of world production)

	1992	1993	1994	1995	1996	1997	1998
Chile	23	24	25	27	31	32	34
U.S.A.	21	21	21	20	19	19	17
Canada	9	9	7	8	7	6	7
Zambia	5	5	4	4	3	3	4
Peru	4	4	4	4	5	5	4
Europe	4	4	4	4	3	3	3
China	4	4	5	5	4	4	3
Asia excluding China	8	8	8	9	8	8	9
Others	21	21	22	21	20	19	18

Source: World Metal Statistics (various issues).

View Table

Table 2.

World Copper Production by Countries or Regions

(Percentage of world production)

	1992	1993	1994	1995	1996	1997	1998
Chile	23	24	25	27	31	32	34
U.S.A.	21	21	21	20	19	19	17
Canada	9	9	7	8	7	6	7
Zambia	5	5	4	4	3	3	4
Peru	4	4	4	4	5	5	4
Europe	4	4	4	4	3	3	3
China	4	4	5	5	4	4	3
Asia excluding China	8	8	8	9	8	8	9
Others	21	21	22	21	20	19	18

Source: World Metal Statistics (various issues).

A. Introduction

59. The purpose of this chapter is to examine, in a stylized theoretical framework, whether the presence of sizable exhaustible resources in an economy affects the path of optimal primary fiscal balances. More specifically, could the existence of nonrenewable resources create a case for transitory but persistent fiscal surpluses? We found that for economies heavily endowed with nonrenewable resources, like Chile, that is generally the case. During the time when fiscal revenues are derived from an exhaustible resource the government would run fiscal surpluses which would permit the replacement of nonfinancial wealth with financial assets. The return on those financial assets would be used in future periods to finance government expenditures. Government preferences regarding the welfare of different generations and the size of the finite resource determine the size of the initial surpluses and, for a steady tax burden over time, also the path for government expenditures.

60. The issue of nonrenewable resources and its optimal depletion has been discussed at length since Hotelling’s (1931) seminal paper. The topic of fiscal policy in presence of nonrenewable resources has received recently some attention since it is of great relevance to a group of countries, like Chile, in which the exploitation of exhaustible endowments have a significant impact on their economies and fiscal stances. This literature has focused on general conditions for policy sustainability, on financial and wealth indicators to track the evolution of government solvency, and on intergenerational transfer issues in presence of depletable resources.¹⁹

61. The relevance of the issue discussed in this chapter is intrinsically linked to the economic size of the nonrenewable resource. In the case of Chile, total copper reserves amount to 163 millions of metric tons or 26 percent of total world reserves,²⁰ the largest reserve base for any country. The economically usable reserves total 88 millions of metric tons or 28 percent of world reserves. At the current rate of production, Chile has 26 years of economically usable reserves, and almost 50 years of total reserves (which can become usable as technology evolves).

62. Assuming a decade-average copper price of US$1 per pound and using Chile’s 1998 GDP and copper-price discount,²¹ the value of total reserves is equivalent to 2.5 times the annual GDP, while economically usable reserves stand to about 1.8 times GDP. Moreover, using an estimated total mining cost of US$0.7 per pound, the net worth of total reserves would amount to 70 percent of 1998 GDP, and economically usable reserves would represent 50 percent of 1998 GDP. In the fiscal accounts, fiscal revenues only from the state copper company CODELCO have averaged 2.2 percent of GDP in the 1990s. It can then be presumed that fiscal policy in Chile should be subject to the particular considerations that this paper intends to highlight.

63. The chapter is organized as follows: Section B presents a simple framework to analyze fiscal policy in the presence of nonrenewable resources. Section C restates the main findings and policy implications. Appendices I and II develop in detail the model presented in Section B.

B. A Stylized Model of Fiscal Policy with Nonrenewable Resources

64. This section outlines a simple extension of the nonstochastic overlapping generation (OLG) model which we developed to better understand the economic implications of nonrenewable resources on fiscal policy.²² A basic two-generation OLG model is set in the context of a small open economy with free trade in goods and financial assets with the rest of the world. In addition to consumers there is a government which provides a public good. The government finances its operations with lump-sum taxes levied on consumers and with the proceeds from the exploitation of an exhaustible resource it owns. The country is assumed to have no influence on the international price for the exhaustible resource.

65. We also assume that there is no production in the economy and consumers are endowed with a constant amount of the consumption good in every period. Consumers make their consumption/saving decisions taking into consideration their intertemporal preferences, the interest rate, the lifetime endowment, and taxes to be paid to the government. Consumers are born with no assets and leave none to their offsprings. In every period consumers derive utility from the consumption of both private and public goods. The public good is consumed in the same amount by all consumers alive in the period that the good is provided.²³

66. The government decides on the level of taxation and the provision of the public good taking into account the utility of both current and future generations. We assume that the government pursues only policies that are consistent with public sector solvency.²⁴ Therefore, the present value of planned primary budget deficits cannot be greater than the government’s initial total wealth, including its nonfinancial wealth which in this case comprises only the market value of the reserves of the exhaustible resource. In addition, to abstract from political-economy considerations we assume that the government counts with commitment mechanisms to prevent intertemporal inconsistencies in its decision making process.

67. For the sake of simplicity, we also assume that there are no domestic assets. Both the government and consumers can accumulate foreign assets or liabilities at a given international interest rate.

68. The distinctive feature of the framework presented here is that the government receives an endowment for a finite number of periods. The present value of the stream of proceeds derived from such endowments is considered the government’s nonfinancial wealth. Total government wealth at any period of time comprises both nonfinancial and financial wealth, the latter consisting of net financial asset holdings.

69. For simplicity we assume that the international interest rate is constant over time, the government’s endowment is constant during the periods it exists, the world price for the resource is given and constant, and the per capita lump-sum taxes are constant over time and across generations. The latter assumption allows to focus on the evolution in the per capita provision of the public good. That is, for a constant-over-time tax burden per capita, what path of the primary fiscal stance would permit, for example, a constant or increasing provision of the public good?

70. In this set up we obtained that the path of the per capita provision of the public good and the primary fiscal balance depend on the government’s intergenerational preferences. Thus, if the government cares strongly for future generations it will pursue a policy of increasing per capita expenditures over time which will require larger initial primary fiscal surpluses. In contrast, if the government’s preferences are biased toward present and near-future generations, government expenditures per capita will diminish which will determine lower initial surpluses. Of course, an intermediate case in which the government’s preferences determine a constant per capita provision of the public good is also possible.

71. These three cases are depicted in Figure 1a (in per capita terms) and Figure 1b (in percent of GDP). The fine solid lines show government expenditures which are constant, increasing and decreasing in the top, middle and bottom graphs respectively. Constant taxes are shown with bold dashed lines, while the income from the non renewable resource is depicted with fine dashed lines. The resulting primary fiscal deficit is presented in bold solid lines. The paths of primary deficits show in general an initial primary surplus²⁵ i.e., the replacement of nonfinancial wealth with financial assets. The accumulation of financial assets implies higher future interest income and thus the ability to run primary deficits. Case I and ii show a clear pattern of primary surplus when the finite resource exists and primary deficits thereafter. Case iii shows an initial primary surplus followed by a deficit that eventually turns back to a surplus.²⁶

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Paths of Primary Deficits

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Paths of Primary Deficits

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72. Moreover, as illustrated in these figures, the less biased government preferences are toward present generations, the higher the initial surpluses. Conversely, initially weaker primary fiscal stances, ceteris paribus, show implicitly the government’s relative disinterest for the future generations, highlighting the intergenerational implications of policies, i.e., lower sustainable primary deficits in the future and a lower provision of the public good.²⁷

73. Furthermore, counter to some casual views that a larger depletable resource would merit less an initial surplus (because it would resemble more closely a permanent resource) we found, as displayed in Figure 2a and 2b, that as long as the resource is finite the larger its size the higher the optimal initial primary surplus in all cases. Also, Figure 3 shows, for the per capita constant expenditure case, that the initial per capita surplus moves equiproportionally with the present value of the endowment, i.e., the percentage increase in the primary surplus is the same as that of the endowment.²⁸

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Price or Volume Effect

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Price or Volume Effect

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Sensitivity of Constant-Expenditure Primary Deficits to Endowment Size

(In per capita tenns)

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C. Conclusion and Policy Implications

74. The aim of this chapter has been to analyze fiscal policy in presence of nonrenewable resources that provide a source of temporary revenue for the government. The question posed has been: what would be the optimal path for the primary balance in those circumstances? We constraint the answer to a smaller subset by assuming that lump-sum taxes are constant over time. Thus we ask, for the same tax burden per capita across generations, what path of the primary fiscal stance would permit, for example, a constant or increasing provision of the public good? The answer we found is that in general the government needs to run primary surpluses while the finite resource exists. Depending on the government’s intergenerational weights, i.e., how much it discounts future generations’ welfare, the path of primary balances will turn into a permanent or transitory deficit thereafter. In terms of a more general class of questions, the existence of nonrenewable resources will constitute a case for temporary but persistent fiscal surpluses.

75. Two interesting results were also obtained. We found that the larger the resource the higher the optimal initial primary surplus. Moreover, the per capita primary surplus is shown to move equiproportionally with the size of the finite endowment for the constant expenditure case.

76. Notwithstanding the robustness of the results obtained, several caveats apply:

• In the model developed, public expenditure is purely a consumption good. In the case where public expenditure is also investment (both in human and physical capital), the analysis becomes more complicated since socially beneficial projects (in presence of, for example, high returns or positive externalities) could determine a path of initially optimal primary deficits because it may be optimal to invest heavily in the initial periods.²⁹ Nonetheless, ceteris paribus, the existence of a nonrenewable resource would imply a stronger initial primary balance (larger surplus or lower deficit) than otherwise.³⁰

• The model also assumes perfect foresight. However, even if the size of the resource or its future economic value were uncertain,³¹ as long as the government is risk-neutral the general result derived above would be maintained.

• The model also ignores optimal depletion issues by assuming a given rate of exploitation of the natural resource. If the government could decide on the rate of exploitation the problem would become more complex, as new factors would enter into the analysis, but the overall conclusion of the model would still be valid. This is so since it is the net present value of the resource what matters for tax and public expenditure, and any change in the path of the proceeds from the exploitation of the nonrenewable resource will only affect the pattern of the primary balance. The optimal rate of exploitation will depend on production costs and on the intertemporal path of the world price for the resource (on which the country may have an effect if it accounts for a significant share of world output and if the degree of substitutability in consumption is not too high). Given that path of extraction, however, it is still true that the more the government is concerned about future generations, the higher would be the initial surpluses (or the lower the initial deficits).

• With respect to ownership, the fact that we assume that the nonrenewable resource belongs directly to the government should not affect the results. Similar patterns for the path of the primary balance would be expected provided that, if the resource is privately exploited, the government still is able to appropriate its net present value (through for example levying royalties).³²

• An important dimension assumed away in the model is that of private offsetting of public savings. The model, for simplicity, rules out explicitly bequest and intergenerational gifts, so that there is no possible offsetting. Conditions for full offsetting in savings are generally very strong, and with partial offsetting the general result for the pattern of primary balances would still be preserved since governments’ intergenerational redistribution policies cannot be fully undone by private agents.³³

• Lastly, there is an important political-economy consideration not addressed by the model. This is the fact that it may be difficult for governments to resist pressures to spend when fiscal accounts are persistently in surplus. The model developed above ignores this type of issues, but it can still serve well to highlight the intergenerational implications of such pressure-induced policies, given the zero-sum nature of the problem.

A. The Problem

77. Nearly two decades ago, Tobin aired in his presidential address to the Eastern Economic Association the idea of taxing international capital flows to reduce exchange rate volatility and to preserve and promote the autonomy of national macroeconomic policy.³⁵ The crises of the European Monetary System in 1992 and 1993, of Mexico in 1994-95 together with the recent Asian crisis, have prompted calls from policy making circles and from some members of the economic profession to control cross-country capital flows.³⁶ The renewed interest in taxing capital flows follows from growing interest on the costs and benefits of capital flows and of government policies designed to limit or modify their composition. The Bank for International Settlements (BIS) indicates that more than 40 percent of all foreign exchange transactions have a maturity of two days or less with about 80 percent of all foreign exchange transactions involving “round trips” of seven days or less. Many observers, e.g., Eichengreen and Wyploz as well as Frankel (1996), believe that much of that trade has little to do with “fundamentals,” is destabilizing and reduces welfare.³⁷ Therefore, following that argument, a Tobin tax that curbs welfare-reducing short-term capital flows without affecting welfare-enhancing long-term flows, should represent a Pareto improvement.

78. The reasons generally advanced for restricting capital flows fall into three categories:³⁸

• As indicated by the Mundell-Fleming model, monetary policy efficacy (in creating a wedge between domestic and foreign interest rates) is much reduced in a world of fast asset market adjustment and high substitutability between domestic and foreign currency denominated assets. Capital controls would preserve and perhaps expand the autonomy of monetary policy.

• Given the distortions to the competitive equilibrium such as private investors motivated by noise trading, band wagons and bubbles—what Frankel calls pathological speculation—or implicit government guarantee of banks’ external liabilities, capital flows can be welfare-reducing. Controlling them would restore the first best.

• Given that multiple equilibria are possible, capital controls could help either in keeping the “good” equilibrium, or in moving the economy to a relatively higher welfare equilibrium.

  Therefore, arguments for “throwing sand in the wheels of international finance” will invariably have as common elements among them the assumption of departure from the competitive equilibrium or “market failure,” and the assumption that restrictions on capital flows will thus be welfare-enhancing.

79. Like other countries in Latin America and Asia, Chile faced a surge in capital inflows at the beginning of the 1990s. According to Zahler (1997), the most important dilemma faced by policymakers in the 1990s in Chile was that internal balance required interest rates higher than abroad—at a time in which Chile faced a decreasing country risk and expectations of currency revaluation—while external balance was inconsistent with the appreciation of the currency. The authorities favored the introduction of controls on capital inflows to offset, or at least moderate, the appreciation of the currency while keeping the interest rate differential required for reducing the excess of desired expenditure over output. Therefore, Chilean controls on capital flows have the objectives of “reducing potential effects on macroeconomic stability, increasing the effectiveness of monetary policy, and imposing prudential regulations on banks and institutional investors” (Le Fort and Budnevich, 1996), and as such their rationale is to be found in the three usual reasons advanced for capital controls which were discussed above.

80. In the 1990s, regulations in Chile affecting both capital inflows and capital outflows were significantly altered. The main control on inflows has been an asymmetric Tobin tax, the one-year unremunerated reserve requirement (URR), or encaje, imposed in 1991 on foreign loans and fixed-income securities. Although the URR was initially aimed at debt-instruments, its coverage was later extended to certain portfolio and some foreign direct investment (FDI) flows. Between 1991 and 1997, the coverage of the URR was widened and the rate of the URR increased. At present, the URR has been suspended—its rate is zero percent. In contrast, controls on capital outflows were relaxed during the 1990s. The authorities reduced the minimum stay period for foreign investment in Chile; increased the maximum share of foreign assets in total assets that commercial banks, pension funds and mutual funds are allowed to hold; and liberalized outward FDI rules.

81. This paper has two objectives. First, to review the evolution of regulations affecting capital flows in Chile, their impact on specific flows, and to discuss methodological problems in measuring net inflows and short-term capital inflows. Second, to survey and critically assess the most recent empirical evidence on the effectiveness of the Chilean URR in achieving four policy objectives: to increase the effectiveness of monetary policy; to reduce total net capital inflows; to reduce both the rate of real exchange rate appreciation and its variance; and to alter the composition of net capital inflows against short-term net capital inflows. Sections B and C cover those two objectives. Section D concludes the paper indicating directions for future research and drawing policy implications.

B. Evolution of Capital Account Restrictions in Chile in the 1990s

82. Chile’s gradual approach to opening its capital account was influenced both by macroeconomic policy concerns in a small, open developing economy, and Chile’s first unhappy experience with rapid opening of the capital account in the early 1980s.³⁹ In early 1990’s the main concern of policymakers with the opening strategy was to (i) maintain monetary policy independence; (ii) prevent excessive appreciation of the real exchange rate; and (iii) moderate the buildup of speculative short-term liabilities. As fiscal policy in Chile was assumed to have a small overall impact on spending (Massad (1998)), monetary policy became the main tool for stabilization. Some controls on capital flows were judged to be needed to prevent interest rate arbitrage with capital mobility and limited exchange rate flexibility. Controls on short-term flows aimed at preventing potentially large adjustment costs on the real economy from real exchange rate volatility associated with sudden reversals of capital flows.

83. To achieve the above objectives Chile used three main instruments to regulate capital flows.⁴⁰ These were a gradual liberalization of outflows, a one-year nonremunerated reserve requirement (URR) to be deposited at the central bank on inflows of certain short-term capital, and minimum ratings and maturity requirements for the issuance of bonds or equity abroad by Chilean residents. The rules are enforced by requiring that most inflow- and many outflow-related foreign exchange transactions take place in the formal foreign exchange market.⁴¹

84. This section discusses the evolution of the controls over the 1990s and the behavior of the various components of capital flows. It also reviews a number of methodological issues related to assessing the impact of the controls on capital flows and their treatment in the literature on Chile. The main findings are: (I) the URR has been progressively tightened as a result of shifts of capital inflows to flows not subject to the URR; and (ii) there are serious methodological problems in measuring net inflows and short-term capital flows into Chile in many of the reviewed studies, which may undermine some of their conclusions on the effect of the URR on capital flows and the term-structure of the flows.

Restrictions on capital outflows

85. Restrictions on capital outflows in Chile were gradually reduced over the decade (Table 1). Outward foreign direct investment (FDI) was liberalized at an early stage in 1991-92, which was accompanied by a gradual liberalization of bank lending abroad. Since 1992 institutional investors’ ability to invest abroad has also been gradually liberalized. Finally, the minimum holding period of capital was reduced from three to one year in 1995, which in ' 1998 is the main remaining control on capital outflows.⁴² The rationale for maintaining the minimum-stay requirement is related to concerns about the volatility of capital flows. Some limits also exist on banks’ and institutional investors’ ability to invest in foreign securities, but these are justified mainly for prudential reasons.

Table 1.

Chile: Evolution of Restrictions on Capital Flows in the 1990s

Table 1.

Chile: Evolution of Restrictions on Capital Flows in the 1990s

	1991	1992	1993	1994	1995	1996	1997	1998
Inflows
URR - rate	20% (Jun) or LIBOR (Jul)	30% (May, Aug) or LIBOR+2.5%; LIBOR+4% (Oct)			Increase in the implicit cost of URR (Jan) by requiring to be constituted in US$ only, compared to any currency before.			10% (Jun) 0% (Sep)
- coverage	+ new credits except trade credits (Jun)	+ foreign currency deposits (Jan) in commercial banks.			+ secondary ADRs (Jun).	+ 1 yr limits on renewal of credits (May).	+ small credits exemption reduced (<US$100 million).
	+ renewals of credits (Jul).				- new borrowing for old debt exempt (Dec).	+ speculative FDI excluded from DL600.
						- small credits excluded (<US$200 million) (Dec)
Minimum rating - bonds		foreign issuance allowed for A-rated companies (May), issuance of convertible bonds allowed (Oct). A-	foreign rating required.	BBB+ (companies) BBB (banks)				A/B (banks) BB (companies)
-ADRs				BBB-				BB- (companies) BBB- (banks)
Minimum amount and maturity
- bonds	foreign issuance limited	US$50 million		US$25 million -4yr minimum maturity				minimum amount to 0 (Jun)
-ADRs		US$50 million		US$25 million; US$10 million for prior issuers				0 (Jun)
- banks		limits on forex holdings increased
-FDI			US$1 million
Outflows
- minimum stay	5 (FICES) 3 other				1 yr (other) (Aug)
- pension fund rules		for asset ownership allowed up to 1.5% of assets (Jan).		increased to 6% (Nov)	increased to 9% (May)	limit can be increased to 12% (Apr)
- commercial banks	25% of forex deposits can be inv. abroad (Feb)	limit increased to 80% (Mar).		can invest in for. banks 20% of capital and reserves;risk weighted assets 10 times total equity (Sep).				FDI limit increased to 40% of capital in one country or 70% of capital overall.
	trade financing included in above
	limit increased to 40% (Apr)
- outward FDI	procedures eased and FDI allowed with own forex or via informal market
- mutual funds and other				insurance companies for inv. limits incr. to 10%, mutual funds to 30%				mutual fund limit eliminated (Jun)

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Table 1.

Chile: Evolution of Restrictions on Capital Flows in the 1990s

	1991	1992	1993	1994	1995	1996	1997	1998
Inflows
URR - rate	20% (Jun) or LIBOR (Jul)	30% (May, Aug) or LIBOR+2.5%; LIBOR+4% (Oct)			Increase in the implicit cost of URR (Jan) by requiring to be constituted in US$ only, compared to any currency before.			10% (Jun) 0% (Sep)
- coverage	+ new credits except trade credits (Jun)	+ foreign currency deposits (Jan) in commercial banks.			+ secondary ADRs (Jun).	+ 1 yr limits on renewal of credits (May).	+ small credits exemption reduced (<US$100 million).
	+ renewals of credits (Jul).				- new borrowing for old debt exempt (Dec).	+ speculative FDI excluded from DL600.
						- small credits excluded (<US$200 million) (Dec)
Minimum rating - bonds		foreign issuance allowed for A-rated companies (May), issuance of convertible bonds allowed (Oct). A-	foreign rating required.	BBB+ (companies) BBB (banks)				A/B (banks) BB (companies)
-ADRs				BBB-				BB- (companies) BBB- (banks)
Minimum amount and maturity
- bonds	foreign issuance limited	US$50 million		US$25 million -4yr minimum maturity				minimum amount to 0 (Jun)
-ADRs		US$50 million		US$25 million; US$10 million for prior issuers				0 (Jun)
- banks		limits on forex holdings increased
-FDI			US$1 million
Outflows
- minimum stay	5 (FICES) 3 other				1 yr (other) (Aug)
- pension fund rules		for asset ownership allowed up to 1.5% of assets (Jan).		increased to 6% (Nov)	increased to 9% (May)	limit can be increased to 12% (Apr)
- commercial banks	25% of forex deposits can be inv. abroad (Feb)	limit increased to 80% (Mar).		can invest in for. banks 20% of capital and reserves;risk weighted assets 10 times total equity (Sep).				FDI limit increased to 40% of capital in one country or 70% of capital overall.
	trade financing included in above
	limit increased to 40% (Apr)
- outward FDI	procedures eased and FDI allowed with own forex or via informal market
- mutual funds and other				insurance companies for inv. limits incr. to 10%, mutual funds to 30%				mutual fund limit eliminated (Jun)

86. Liberalization of capital outflows is likely to increase outflows but it could also increase inflows with an uncertain impact on net flows. Outflow liberalization has been suggested in the literature as one way of reducing the potentially adverse macroeconomic consequences of large inflows of capital (Quirk-Evans 1995, Schadler et al. 1993). Liberalization of outflows should increase residents’ holdings of foreign assets thus reducing net inflows of capital. This effect seems to be present in the Chilean case. Available data show that following the liberalization of outward FDI and portfolio investment, these outflows from Chile have increased over the decade, reaching nearly 3-5 percent of GDP in recent years (Figure 1). This figure and Figure 2 also show that total capital outflows from Chile have been important compared to the size of the inflows. However, outflow liberalization may also lead to larger inflows of capital. A number of authors including Williamson (1991) in general, and Laban and Larrain (1998) and Laurens and Cardoso (1998) in the case of Chile, have argued that liberalization of outflows by reducing perceived uncertainty of investing in the home country and by lowering domestic asset prices can also increase capital inflows. None of the papers reviewed offer recent empirical estimates of the effect of the liberalization of outflows on net inflows of capital in Chile.⁴³

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Chile: Components of Gross Capital Outflows

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: Different Definitions of Capital Inflows

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

Sources: Central Bank of Chile; and Fund staff estimates.1/ Adjusted net inflows=Net inflow less debt pre-payments I

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Restrictions on inflows of capital

87. Controls on inflows such as minimum risk classifications, maturity and amount for the issuance of securities abroad were gradually relaxed over the decade (see Table 1). In bonds, the minimum amounts were gradually eliminated, but a four-year minimum maturity and a certain minimum rating remain. For ADRs a minimum rating remains but minimum amounts have been eliminated. These rules aimed mainly at preventing adverse effects on country risk by potentially insolvent borrowers abroad. Most of these rules are more of a prudential nature.

88. The main instrument for restricting capital flows in Chile has been an unremunerated reserve requirement (URR) on capital inflows. The URR is an indirect, price-based measure in the form of a one-year compulsory deposit of a fraction of capital inflows at the central bank. It is expected to reduce capital inflows by increasing the cost of foreign short-term capital. The URR was to cover all foreign loans except trade credits, but its coverage has been extended over time to nondebt flows as well. It was set initially in 1991 at 20 percent and importers of capital could either make the deposit at the central bank or pay an upfront fee equivalent to the interest cost of the URR. Its implicit cost varies according to the maturity of the inflow. For example, the 30 percent URR has been estimated to increase the cost of borrowing by about 26 percent for one month maturities, or 2 to 3 percentage points for one year maturities (for more details see Cardoso-Laurens 1998 or Le Fort-Sanhueza 1998).⁴⁴ Le Fort and Budnevich (1996) note that the expectations of an appreciating exchange rate and high returns to capital in Chile rapidly compensated the costs implicit in the URR especially on portfolio inflows—the financial cost of the URR of 1-3 percentage points per annum was easily offset by an expected appreciation the exchange rate. Both coverage and the rate have been subject to change over the decade (see Table 1).⁴⁵ The URR was reduced to zero in 1998 in response to more adverse conditions in world financial markets in the aftermath of the Asian crisis.

89. The effectiveness of the URR has been subject of an intense debate in and outside Chile. Dooley (1996) and Quirk and Evans (1995) note that studies in general on the effectiveness of capital controls have suffered from the lack of widely accepted definition of effectiveness. A number of studies have analyzed the effectiveness of the URR in reaching its macroeconomic objectives in Chile with the use of econometric analysis, which will be discussed in more detail in Part C. This section instead examines effectiveness in a more informal way, by looking at how the various capital flows responded to the URR and how the restrictions evolved over time. The literature (summarized in Dooley 1996) in general points out that controls can be effective in the short-run while in the longer-run market participants find ways to evade the controls.

90. The coverage of the URR has been partial in Chile, which may have undermined its effectiveness by allowing substitution possibilities with uncovered flows. Important potentially volatile short-term flows such as trade credits and other nondebt creating capital flows were excluded from the scope of the URR. This was either for constitutional (strong support to export development in the Constitution led to exemption of trade credits from the URR) or practical reasons (difficulty of controlling informal flows as only formal market transactions are notified to the monetary authorities). Portfolio flows were initially exempt, but subsequently covered. Exempt longer-term flows are government credits, FDI and other capital creating flows such as primary issuance of ADRs (Le Fort-Sanhueza, 1997).

91. Controls on capital inflows were also frequently tightened in Chile over the 1990s. There were three major tightenings in the URR either in terms of extension in the coverage or increase in the rate during the decade. The first tightening took place in 1992 (rate increased from 20 to 30 percent). Data from the central bank show that initially in 1992 the URR covered about half of total gross inflows, but in the subsequent years its coverage declined to 24 percent (Figure 3).⁴⁶ This may suggests that while the URR may initially have been effective, participants may have found ways to circumvent the restrictions over time. After further tightening in 1995 (extension to ADRs and change in base to U.S. dollars) and 1996 (exclusion of speculative investment from FDI) the share of URR covered flows in total gross inflows increased again to 30-40 percent. Similar estimates of coverage are given by Le Fort and Sanhueza (1997). While many other factors are likely to have influenced the various flows, the behavior of the individual components of capital inflows in Chile may suggest some pattern of a shift from covered into uncovered inflows in response to tightening of the URR. For example, Figure 4 seems to indicate that when the URR was extended to ADRs in 1995, another exempt inflow (FDI) started to grow faster.⁴⁷ While some of the increase is likely to coincide with the start of large investment projects in the mining sector, Le Fort and Sanhueza (1997) and Laban and Larrain (1998) note that in 1995-1996 FDI became a major channel for portfolio inflows after the URR was extended to ADRs in 1995.⁴⁸ Once the rules on FDI were tightened in 1996 to exclude speculative capital, again another flow, trade credits by foreign suppliers and importers, started to increase gradually as markets may have found a new channel for exempt inflows (Le Fort and Sanhueza, 1997, and Soto, 1997). This may have led to migration of capital flows via the disintermediation of the taxed domestic banking system. This would be supported by the fact that since 1995, despite increased trade flows, trade credits by domestic banks declined each year lowering their share in total credits substantially.

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Chile: Share of URR-covered Flows in Gross Capital Inflows

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

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Chile: URR Tightening (1991, 1995, 1996) and Behaviour of Affected Gross Inflows

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

Sources: Central Bank of Chile; and Fund staff estimates.1/ DL600-FDI receiving special incentives.

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92. Despite the URR, capital flows in Chile have been volatile during crisis periods. In response to the crisis in world financial markets large capital outflows especially of portfolio and other short-term capital took place in 1995 and in 1997-1998 amounting to about 5-6 percent of GDP in the latter year. Although the URR never intended to isolate Chile from events in world markets, one implicit aim of the URR was to reduce the volatility of capital flows. Few of the studies reviewed have measured the impact of the URR on this. Laurens and Cardoso (1998) offer some estimates of standard deviations of different components of net inflows. Their results show that standard deviation of short-term capital increased over time. One could argue that without the URR volatility could have been even higher than at present, or that because of partial coverage of the URR and migration of flows it has not been effective in meeting this policy goal. Whether the URR was effective in reducing volatility of capital flows in Chile may be a topic for further research.

Methodological issues

93. The estimates of the impact of the URR on net capital inflows may be biased if the analysis does not take into account the possible effect of other factors which may affect net inflows. In the case of Chile, these factors include in particular the liberalization of outflows and the government’s debt pre-payment and debt conversion program in the 1990s.⁴⁹ The effect of the liberalization of capital outflows was discussed above; none of the studies reviewed have controlled for this factor. Regarding the government’s debt pre-payment and debt-conversion programs, Figure 1 shows that those programs resulted in large outflows, amounting to 2-3 percent of GDP especially in the years that the URR was tightened.⁵⁰ Thus net inflows may have declined due to factors other than the URR after its tightening. Figure 2 suggests that the patterns of net inflows, and net inflows adjusted for the above two government programs are quite different. Laurens and Cardoso (1998) made an attempt to take account of this problem by using net (private) inflows of capital, which excludes the impact of the public debt payments on net inflows. Valdes-Prieto and Soto (1997) also include only short-term credits to the private sector in their estimation (Table 2).

Table 2

Chile: Summary of Selective Quantitative Studies on the Effects of the URR on Capital Inflows ^{1/ 2/}

^1/This table reports only those results that the authors consider to be robust.

^2/The words “positive” and “negative” refer to the sign of the effect of the URR on the variable analyzed in the corresponding column.

^3/The variable used is short-term capital inflows.

^4/The variable used is medium- and long-term capital inflows.

Table 2

Chile: Summary of Selective Quantitative Studies on the Effects of the URR on Capital Inflows ^{1/ 2/}

Author	Data	Capital Flow Measure Used	Domestic Interest Rate - Interest Rate Differential (1)	Magnitude of Capital Flows (2)	Real Exchange Rate (3)	Ratio of Short-Term to Long-Term Capital Flows (4)
1. Eyzaguirre& Schmidt-Hebbel (1997)	Monthly 1991/1—1996/6	Changes in central bank reserves less cummulated net foreign liabilities of the capital account Ratio of short-term to medium- and long-term gross foreign liabilities		Positive (Indirect)		Negative
2. Herrera &Valdés-Prieto (1997)	Monthly 1991/1-1996/8		Positive
3. Valdés-Prieto &Soto (1997)	Quarterly 1987/4-1996/4	Net short-term credit inflows to the private sector plus errors and omissions				Negative 3/
4. Soto (1997)	Monthly 1991/—1996/6	Total net capital flows Ratio of short-term net debt to medium- and long-term net debt	Positive (In the medium term)	Positive (On impact) Negative (In the short term)	0 (Level) Negative (Volatility)	Negative (In the medium term)
5. Edwards (1998)	Quarterly 1981/1-1996/6	Changes in reserves of the central bank	Positive (In the short term)		0
6. Laurens &Cardoso (1998)	Quarterly 1985/—1994/4	Net short-term and medium- and longterm capital inflows		Negative 3/ (In the short term)		Negative 3/ (In the short term) Positive 3/ (In the medium term) Negative 4/ (In the medium term)

^1/This table reports only those results that the authors consider to be robust.

^2/The words “positive” and “negative” refer to the sign of the effect of the URR on the variable analyzed in the corresponding column.

^3/The variable used is short-term capital inflows.

^4/The variable used is medium- and long-term capital inflows.

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Table 2

Chile: Summary of Selective Quantitative Studies on the Effects of the URR on Capital Inflows ^{1/ 2/}

Author	Data	Capital Flow Measure Used	Domestic Interest Rate - Interest Rate Differential (1)	Magnitude of Capital Flows (2)	Real Exchange Rate (3)	Ratio of Short-Term to Long-Term Capital Flows (4)
1. Eyzaguirre& Schmidt-Hebbel (1997)	Monthly 1991/1—1996/6	Changes in central bank reserves less cummulated net foreign liabilities of the capital account Ratio of short-term to medium- and long-term gross foreign liabilities		Positive (Indirect)		Negative
2. Herrera &Valdés-Prieto (1997)	Monthly 1991/1-1996/8		Positive
3. Valdés-Prieto &Soto (1997)	Quarterly 1987/4-1996/4	Net short-term credit inflows to the private sector plus errors and omissions				Negative 3/
4. Soto (1997)	Monthly 1991/—1996/6	Total net capital flows Ratio of short-term net debt to medium- and long-term net debt	Positive (In the medium term)	Positive (On impact) Negative (In the short term)	0 (Level) Negative (Volatility)	Negative (In the medium term)
5. Edwards (1998)	Quarterly 1981/1-1996/6	Changes in reserves of the central bank	Positive (In the short term)		0
6. Laurens &Cardoso (1998)	Quarterly 1985/—1994/4	Net short-term and medium- and longterm capital inflows		Negative 3/ (In the short term)		Negative 3/ (In the short term) Positive 3/ (In the medium term) Negative 4/ (In the medium term)

^1/This table reports only those results that the authors consider to be robust.

^2/The words “positive” and “negative” refer to the sign of the effect of the URR on the variable analyzed in the corresponding column.

^3/The variable used is short-term capital inflows.

^4/The variable used is medium- and long-term capital inflows.

94. Another important measurement problem is related to the definition of short-term capital flows, which in the Chilean case raises three issues: (i) the role of nondebt creating flows in short-term capital; (ii) inclusion of portfolio flows in short-term capital; and (iii) differing definitions of short term debt in Chile.

95. First, given the partial coverage of the URR and the possibility of substitution between different liabilities, the results of any analysis excluding other short-term nondebt creating capital from total short-term flows are likely to be biased. As discussed above, inflows of nondebt creating short-term capital not covered by the URR can be important (Le Fort and Sanhueza 1997).⁵¹ This includes transactions reflected in errors and omissions and other nondebt creating short-term capital (“otro capital”) categories of the balance-of-payments. Figure 5a shows that the amounts of these transactions can be important. However, many of the reviewed studies use either short-term debt or another partial measure of net short-term capital inflows to measure the effectiveness of the URR in reducing short-term capital inflows to Chile. Valdes-Prieto and Soto (1997) include errors and omissions but exclude “otro capital” in addition to short term private credit in their estimate of short-term capital, and finds some impact of the URR in reducing short-term capital flows. Le Fort and Budnevich (1996) also discuss the impact of the URR on short-term debt and find that it has declined as share of total debt. Eichengreen et al. (1998) discuss the impact of tightening of the controls in 1995 on short-term debt only, but conclude that the impact of the controls on the term-structure of debt is ambiguous. In the Chilean case the focus on short-term debt and exclusion of other short-term capital flows in the balance-of-payments in assessing the effectiveness of the URR may be particularly problematic as the aim of the government seems to have been a reduction in “speculative” short-term flows (Massad 1998) and not only debt flows.⁵²

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Chile: Net Short-term Capital Flows - Total, Debt and Nondebt Flows

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

Sources: Central Bank of Chile; and Fund staff estimates.

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96. Second, the exclusion of portfolio flows from short-term flows is likely to bias the results of the studies in reducing short-term flows as well. By extending the coverage of the URR to portfolio flows in 1995 the authorities implicitly seem to have considered that portfolio flows are to be included in the category of “undesirable” or speculative short-term flows, or that they contain capital inflows that are evading the URR. Furthermore, Figure 4 suggests that portfolio flows have been volatile and responded rapidly to changes in market sentiment. Given that one of the objectives of the URR was to reduce “speculative” capital flows, and that a large part of portfolio flows are likely to fall in the “speculative” category and be of short-term nature, these concerns would argue in favor of including portfolio flows in short-term flows and not in long-term FDI in Chile. Thus it is somewhat surprising that all of the reviewed studies have included portfolio flows in long-term capital. Edwards (1998) mentions the volatility of portfolio flows as an issue but goes no further in addressing the issue in his estimation. An illustrative calculation with a broader measure of the term structure of liabilities (estimated stocks of all short- and medium-term liabilities including portfolio and FDI) shows that the share of short-term liabilities in the total increased slightly until 1995 and only regained the pre-URR levels in recent years at about 20 percent of total (Figure 5b).⁵³

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Chile: Structure of Foreign Capital

Citation: IMF Staff Country Reports 1999, 015; 10.5089/9781451807479.002.A001

Sources: Central Bank of Chile; and Fund staff estimates.

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