Abstract
This Selected Issues paper examines the acceleration of inflation over the past year in Chile, identifying domestic shocks to food and energy prices as main drivers. The paper uses the Jeanne-Rancière model to calculate Chile’s optimal ratio of international reserves to GDP. It analyzes the stabilization properties of Chile’s macroeconomic framework and compares it with alternative policy rules. The paper concludes that Chile’s framework based on an explicit inflation target, a floating exchange rate, and a structural fiscal surplus rule is superior to other arrangements.
I. Supply Shocks, Inflation, and Expectations1
Inflation began to accelerate in the second half of 2007. While partly caused by global developments, inflation rose faster than in many other countries due to simultaneous shocks at home. However, long-term inflation expectations remain anchored close to the 3-percent target, and the recent tightening of monetary policy has bolstered real interest rates.
1. Inflation began to accelerate in mid-2007 after a long period of price stability. Chile’s inflation rate averaged 3½ percent a year between 1997 and 2007, and has remained well within single digits since the introduction of inflation targeting in 1990. After rising to 7¾ percent at end-2007, annual inflation reached close to 9 percent in May 2008—5 percentage points above the Central Bank’s upper tolerance level.
Inflation
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Inflation
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Inflation
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
2. The increase in inflation was driven primarily by food and energy components. Annual price increases in key food staples reached up to 50 percent, and the cost of electricity has been almost 60 percent higher than in the first half of 2007. Given the relatively high weight of food and energy in the consumer price index, these trends dominated price developments of other goods, which have largely conformed to the central bank’s inflation target.
3. In contrast to many other countries, jumps in food and energy prices in Chile also reflect large domestic supply shocks. The contribution of food and fuel components to inflation in Chile is among the highest across emerging market economies, notwithstanding the fact that other countries have a similar or even larger weight on these components (see table below). Since countries are being hit by global shocks in a broadly similar way, the difference in the contribution of price components to inflation largely reflect domestic supply conditions and price subsidies. Chile has none of the latter—instead, natural gas shortages have added to local inflation, and so has a drought that increased the costs of local agricultural products and hampered the production of hydro-electricity.
Food and Fuel Inflation--Weights and Contributions
Food and Fuel Inflation--Weights and Contributions
| Countries | Inflation 03-08/03-07 | Weight (%) | Food Composition | Contr. (%) | Weight (%) | Fuel Composition | Contr. (%) |
|---|---|---|---|---|---|---|---|
| BRA | 4.7 | 21.7 | Food and beverages | 2.4 | 5.0 | Fuels | 0.0 |
| CHL | 8.5 | 27.2 | Food | 4.4 | 4.0 | Fuels | 0.8 |
| COL | 5.9 | 29.5 | Food | 2.7 | 1.1 | Fuels | 0.2 |
| MEX | 4.2 | 22.7 | Food | 1.5 | 3.8 | Gasoline and lubricating oils | 0.2 |
| PER | 5.5 | 47.5 | Food and beverages | 4.4 | 2.5 | Fuels | 0.2 |
| SA | 7.0 | 27.0 | Food | 3.6 | 10.5 | Housing-fuel, power, transport costs | 2.7 |
| CZR | 7.1 | 16.3 | Food + non-alcoholic beverages | 1.8 | 11.4 | Transportation | 0.7 |
| ISR | 3.7 | 17.1 | Food (including fruits and vegs) | 1.9 | 17.1 | Transportation | 0.6 |
| THA | 5.3 | 36.1 | Food + non-alcoholic beverages | 2.9 | 9.1 | Energy | 2.0 |
Food and Fuel Inflation--Weights and Contributions
| Countries | Inflation 03-08/03-07 | Weight (%) | Food Composition | Contr. (%) | Weight (%) | Fuel Composition | Contr. (%) |
|---|---|---|---|---|---|---|---|
| BRA | 4.7 | 21.7 | Food and beverages | 2.4 | 5.0 | Fuels | 0.0 |
| CHL | 8.5 | 27.2 | Food | 4.4 | 4.0 | Fuels | 0.8 |
| COL | 5.9 | 29.5 | Food | 2.7 | 1.1 | Fuels | 0.2 |
| MEX | 4.2 | 22.7 | Food | 1.5 | 3.8 | Gasoline and lubricating oils | 0.2 |
| PER | 5.5 | 47.5 | Food and beverages | 4.4 | 2.5 | Fuels | 0.2 |
| SA | 7.0 | 27.0 | Food | 3.6 | 10.5 | Housing-fuel, power, transport costs | 2.7 |
| CZR | 7.1 | 16.3 | Food + non-alcoholic beverages | 1.8 | 11.4 | Transportation | 0.7 |
| ISR | 3.7 | 17.1 | Food (including fruits and vegs) | 1.9 | 17.1 | Transportation | 0.6 |
| THA | 5.3 | 36.1 | Food + non-alcoholic beverages | 2.9 | 9.1 | Energy | 2.0 |
4. Domestic shocks may also have increased the pass-through of changes in global commodity prices to headline inflation in Chile. Historically, the pass-through of import prices to the CPI has been falling, and inflation has not been very sensitive to spikes in global food and energy prices. For example, dynamic correlations between changes in the CPI and the Chicago Research Bureau’s (CRB) grains and seeds, livestock, foodstuff, and energy sub-indices—computed over the period 2000–2008—are low and not statistically different from zero, unlike in a number of other inflation-targeting emerging markets. In recent months, however, the correlation may have increased, given more precarious domestic supply conditions and the need to import significant amounts of diesel to replace other electricity-generating services.
Commodity Prices and Inflation
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Commodity Prices and Inflation
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Commodity Prices and Inflation
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Inflation expectations and wages
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
1/ Using a rolling average of current and next year expectations.Inflation expectations and wages
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
1/ Using a rolling average of current and next year expectations.Inflation expectations and wages
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
1/ Using a rolling average of current and next year expectations.
Alternative short-term inflation expectations
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Alternative short-term inflation expectations
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Alternative short-term inflation expectations
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
5. Economic agents have reacted to the price shock with higher short-term inflation expectations and a pick-up in wages. Although some domestic prices remain indexed, long-run inflation expectations are a key mechanism for the transmission of recent price shocks to the economy. These expectations have so far increased only moderately, both compared to other emerging economies and the central bank’s inflation target. However, short-run expectations (as generated, for example, by simple recursive models) have ratcheted up as nominal wages have largely caught up with headline inflation.2 Further increases in short- and long-term inflation expectations could add to wage pressures going forward.
Expected 2008 Inflation 1/
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Sources: Consensus Forecasts and Fund staff estimates.1/ Using 2008 inflation expected in April 2007 and April 2008.Expected 2008 Inflation 1/
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Sources: Consensus Forecasts and Fund staff estimates.1/ Using 2008 inflation expected in April 2007 and April 2008.Expected 2008 Inflation 1/
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Sources: Consensus Forecasts and Fund staff estimates.1/ Using 2008 inflation expected in April 2007 and April 2008.6. Similarly to many other emerging markets, real interest rates in Chile—measured using actual or short-run expectations of inflation—have declined over the past year. While the decline looks larger than in many other emerging market economies, the central bank’s 175 basis points increase in interest rates since last August, together with relatively stable long-run inflation expectations, implies that real interest rates based on price expectations with a horizon of one year or more have been constant or even rising over the past year.
Real interest rates and output gaps in inflationtargeting emerging markets
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
1/ Using actual inflationReal interest rates and output gaps in inflationtargeting emerging markets
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
1/ Using actual inflationReal interest rates and output gaps in inflationtargeting emerging markets
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
1/ Using actual inflation
Expectations-based real interest rates
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Expectations-based real interest rates
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Expectations-based real interest rates
Citation: IMF Staff Country Reports 2008, 239; 10.5089/9781451807677.002.A001
Prepared by Nicoletta Batini.
Staff has estimated simple AR(2) and AR(4) short-run inflation expectations models on monthly Chilean CPI data over the period January 2004–January 2007. Out-of-sample dynamic forecasts using both models suggest that one-month-ahead expectations by myopic agents track closely actual inflation, and rise well above long-run measures of expectations. Short-run expectations under the more inertial AR(4) model rise less, but are still well above the Central Bank target and long-run inflation expectations.
