The Fiscal and Monetary History of
Chile 1960 - 2010
Rodrigo Caputo and Diego Saravia
Comments by Andrew Powell
Research Dept., IDB
My own views, not those of the IDB, its Board if the countries they represent
Great Project
• As I understand it the idea is to apply a variety
of modern economic tools to understand
better fiscal and monetary history of LA
• LA: has such a rich history, economic tools can
help to understand and LA can help us to
understand better those tools…
• Message to organizers: lets have a future
event at the IDB!
The Case of Chile
• Fascinating history, a true laboratory..
• Incredible plot with a cast of many strong
characters and eventually an (almost)
Hollywood ending…
• The case illustrates the need to combine fiscal
and monetary history (not just money)
Comments on the Paper
• Interesting paper, I learnt a lot…
• Some comments on what the authors do
• Some comments on what authors do not do…
Five “Phases” Identified
• 1952-1970. Import substitution strategy, growth almost 4%, budget
deficit around 3% and inflation almost 30%, increasing economic
inefficiencies, slow motion crises and some reforms…
• 1971-1973. Democratic socialism, expansion of government, increasing
direct control in key industries, price controls, but monetary financing
and inflation soared, hyperinflation
• 1974-1983. Stabilization attempts, first more gradual, then deeper,
economic reforms, late 1970’s high growth but increased foreign
increased foreign debt, non-tradable boom, financial liberalization but
weak supervision, early 1980’s devaluation and crisis, bail out of
financial sector, need to generate fiscal surpluses
• 1984-1992: Growth up to 6.2%, fiscal surplus around 1.5% and inflation
averaged 20%, improved financial regulation
• 1992 to date: development of inflation targeting regime, fall (finally) in
inflation, flexible exchange rate and fiscal rules, stabilization fund for
copper and reduction in public debt
Economic Tools Applied
by the Authors
• Import substitution:
• Democratic socialism:
– Government budget constraint - Sargent
– Cagan model: real money balances
= f(inflation expectations)
• Leading up to the 1982 crisis:
– Exchange rate simulation/counterfactual
– Krugman first generation bop. crisis
• Post 1980’s crisis, adoption of inflation targeting
On the Analysis of Government
Budget Constraint
• Sargent (2013), extended to include foreign currency and
indexed bonds
• Question: what is the relationship between the returns on
each of these instruments? Is anything imposed?
• Offhand remark that Government was unable or unwilling
to obtain more debt financing, what were the rates paid
on these instruments, which was it?
• Were there large budget surprises? Was monetary
financing related to the surprise?
• A distinction is made between indexed and non-indexed
debt, but is this important in this period? If so, why?
On the Cagan model
• Demand for money reflects inflation
expectations…
• How are expectations formed, in the empirical
analysis appears to be this period’s inflation (?)
• It is stated both real balances and inflation are
I(1) over the period, but no tests are illustrated,
how is the period chosen?
• Noriega and Ramon-Francia (2013) and Mariscal
and Powell (2013) test for changes in the order of
integration of inflation…
Periods when
Inflation is I(0)
in Chile
Noriega and RamonFrancia (2013)
Mariscal and Powell (2013)
• Dates of breaks
found, considering
fractionally
integrated series.
But neither paper considers a
characterization of inflation
during the 1970’s
Our concern is how to
characterize inflation post the
last break.
Comments on the V-ECM Analysis
• If both real balances and inflation expectations are I(1) and
co-integrated, does this mean (hyper)inflation is a stable
process, could it then have gone on forever?
• Or perhaps they are not consistently, during hyperinflation
perhaps they are I(x) then I(y) and then (z) where z > y > x
But remain co-integrated? That would be quite a different
interpretation
• In fact the ECM term is hardly significant and the return to
equilibrium appears relatively weak
• Recommendation: consider endogenous breaks, could apply
apply new “saturation” techniques that test for an unknown
quantity of breaks of unknown dimension, Hendry, Ericcson
and others…
The Financial Crisis
• I suspect that the financial sector had a bigger
role than described, not just fiscal and money
• Financial liberalization but with weak
supervision, two concerns were:
– Allocation of credit, reflecting non tradable boom
– Related lending, conglomerates etc.
• Strong lessons learned for Chile, and for many
other countries in the region
• In part due to the lessons learned from the
1980’s and 1990’s, LAC survived Global Crisis…
Exit from the Crisis
• It is stated that Chile avoided default unlike
others in the region, as “default not an option”…
• To be applauded of course but I wonder whether
that was an optimal strategy.
• Most of the literature suggests the costs of
default are low, markets are fickle
• It stands out as a moral statement in a paper that
otherwise applies economic tools..
The Reduction in Inflation and
Inflation Targeting
• This is a fascinating period but its given very
little space in the paper
• Inflation was 25% in 1990 when the first
inflation target (band) announced for 1991
• Chile also had exchange rate bands and
inflation targets simultaneously
• Idea was that inflation remained persistently
high largely due to expectations, need to
provide explicit target.
And this seemed to work…
Inflation expectations respond
to lagged inflation and current
Mariscal, Powell and Tavella (2013)
inflation shocks but…
But effect of inflation shocks on
expectations has fallen over time…
Not uniformly the case for
Brazil
Data Sources
• For this, we use an IDB database known as
Revela, www.iadb.org/revela
• But the authors probably have access to
individual inflation forecasts
• Can look at this disaggregated data and
perform additional tests on how Chile’s IT
regime gained credibility…
Other Comments / Puzzles…
• The size of the CB balance sheet and not just
Net Worth is of interest, how did Chile “taper”
after the crisis
• Indexation: how did indexation survive despite
its role leading up to the 1980’s crisis…
• The dollarization vs indexation debate
• And why isn’t Chile “nominalized” today, if
inflation truly under control…