Marco A. Espinosa-Vega

Chile has maintained macroeconomic and financial stability for almost two decades, largely as a result of sound policies. IMF researchers have sought to shed light on the sources of these positive outcomes to contribute to the policy discourse and to identify potential challenges for the years ahead.

Chile seems to have skillfully fended off international contagion from crises in other emerging markets in recent years. Rebucci (2002) studies the daily movements in the peso exchange rate to test the hypothesis of “shift-contagion” from Argentina in 2001. He finds evidence of contagion during some months, at least through end-2001. One interpretation of his finding is that Chile has faced episodes of contagion but has successfully resisted them.

While Chile’s sound economic policies have been well documented over the last decade, less attention has been paid to the institutional arrangements underlying the adoption and sustained implementation of such policies. Espinosa-Vega and Phillips (2003) conclude that time-consistent financial regulation and the constitutional features that have promoted fiscal discipline and central bank independence have been especially important in this regard.

Phillips and Espinosa-Vega (2003) review Chile’s macroeconomic policy framework, which has helped the country endure recent shocks. The country’s fiscal policy aims at a structural balance target that has allowed automatic fiscal stabilizers to operate while providing adequate assurance of sustainability. Chile’s central bank policies, in the context of a floating exchange rate, focus on inflation targeting. The inflation-targeting framework consists of (1) a prespecified continuous inflation target band; (2) a preannounced policy horizon; and (3) timely communication of the authorities’ inflation forecast, the rationale for their policy decisions, and the reasons for any temporary deviations from the inflation target.

Forecasting inflation is an essential element of any inflation-targeting regime. Nadal-De Simone (2000) compares the forecasting performance of three econometric models with a benchmark Box-Jenkins model. He finds that the Box-Jenkins model performs well only in the short run and that including the preannounced official inflation target as an explanatory variable improves the forecast performance of the alternative models. Importantly, Nadal-De Simone (2001) also shows that the decline in inflation variance associated with inflation-targeting regimes has not been accompanied by an increase in output variance in Chile.

The effectiveness of monetary policy depends, among other things, on the degree to which changes in the monetary authority’s target rate are followed by changes in retail banking rates (whether there is fast and complete “pass-through”). Espinosa-Vega and Rebucci (2004) perform a cross-country analysis of the degree of “interest rate pass-through.” Their sample includes some of Chile’s “peer” economies, and some industrial economies. They find that Chile exhibits fast and close to complete interest rate pass-through.

Substantial reforms have also been undertaken in Chile’s financial markets. IMF researchers underscore the fundamental role of Chile’s well-developed and large institutional investor base as a stable source of domestic finance. Luzio (2003) also analyzes remaining policy challenges, such as low liquidity in equity and corporate bond markets, and a high degree of ownership and investor concentration. Recent changes in financial regulation and legislation have sought to address concerns on the relative depth of capital markets while improving capital markets regulation.

Most of the policies and reforms pioneered by Chile in the last two decades have been market oriented. However, Chile has also attracted much attention on the part of both policymakers and academics for having thrown some “sand in the wheels” of capital inflows. In the early 1990s, unremunerated reserve requirements (URRs) were imposed on short-term capital inflows to improve the composition and moderate the total volume of capital inflows, with a view to avoiding sharp reversals.

Although no consensus exists on the effectiveness of such a form of capital control, Laurens and Cardoso (1998) suggest that URRs lengthened the average maturity of capital inflows but had no long-term effect on total capital inflows or the exchange rate, and therefore increased the autonomy of Chile’s monetary policy only to a limited extent. In their evaluation of the impact of URRs, Nadal-De Simone and Sorsa (1999) note that the URRs were enforced effectively—as one might have expected in light of Chile’s generally good record of effective governance. They caution that lessons drawn from the Chilean experience with URRs should not be applied to other countries without taking into account the particular country’s institutional history and record in enforcing regulations.

Sound macroeconomic and financial policies have been usefully complemented by Chile’s open trade policy, which has recently included the unilateral reduction of tariffs and a number of trade agreements. Even so, the large share of natural resources in Chile’s exports might have been expected to be a source of volatility. But Villafuerte (2003) notes that Chile has been able to avoid the “Dutch disease”—episodes where strong exports of natural resources are associated with diminishing rates of growth. He argues that, in the case of Chile, such exports have been associated with positive spillovers and have led to product innovation. He further maintains that, to take full advantage of these spillovers, Chile needs to continue to diversify exports and promote human capital accumulation.

Copper plays an especially important role in the Chilean economy—as a key contributor to exports, GDP, and fiscal revenues. Spilimbergo (1999) finds evidence of a close relationship between copper prices and the Chilean business cycle, though establishing the precise transmission channel between these two variables is a more difficult task. Spilimbergo points out that, unlike other countries endowed with nonrenewable resources, there is limited evidence in Chile of consumption booms being related to copper price booms. He suggests, therefore, that investment could be a more plausible transmission channel between the copper price and business cycles. He also cautions against simplistically attributing Chile’s economic success to high copper prices.

Given the size of copper revenues for the Chilean economy and the fact that the price of copper is considerably volatile, forecasting the price of copper is of paramount importance. The Chilean government adheres to a “structural balance target” that includes adjustments for copper price fluctuations. The rationale for such adjustments relies in large part on the ability to forecast the copper price in the medium term with some degree of accuracy. Phillips (2002) compares the out-of-sample forecasting performance of several models and finds that it is possible to forecast medium-and long-term copper price movements. However, he cautions that there is still significant uncertainty about the copper price steady state and its cyclical properties.

What are the fiscal policy implications for a country that derives important tax revenue from an exhaustible commodity sector? The answer is far from straightforward because it depends on a number of assumptions, including how the tax revenues will be used, whether the economy is in a dynamically efficient equilibrium, and what weight the current government assigns to the well-being of future generations. Alier and Kaufman (1999) remind us that Chilean copper will not be around forever and that it is important to study the welfare implications of alternative fiscal balance paths. They examine a stylized model that assumes a dynamically efficient economy with government provision of public consumption goods and conclude that, in their model, during the years that fiscal revenues are derived from copper, the government should run fiscal surpluses that allow the replacement of nonfinancial wealth with financial assets.