Chile

• Author: Marco A. Espinosa-Vega
• Pages: 9-10

Page 9

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...