José De Gregorio: The world economy, foreign exchange tensions, and recent monetary policy making in Chile

This presentation discusses risks and tensions that have emerged in the global economy due to the ongoing process of world economic recovery and its implications on the Chilean economy. It reviews the decoupling of emerging economies from developed ones in terms of growth, the difficulties endured by developed economies to boost their feeble recovery, Europe’s public debt issues, the high commodity prices and symptoms of overheating in some emerging markets. This scenario has pushed emerging economies’ exchange rates to their lowest levels of the past decade. It stands out that, although an important step to change the composition of world demand, it has created tensions and in some cases has prompted the adoption of policies to mitigate exchange rate adjustments. Capital inflows have added pressure to the exchange rate discussion in some emerging economies and might favor an unhealthy increase in lending and incubate financial fragilities. Chile’s last forex intervention is mentioned. The differences in capital flows between Chile and other countries and episodes of substantial flows into emerging economies are described, emphasizing that large capital outflows from Chile have created a negative net balance. It is also suggested that the current level of the neutral MPR is probably lower than previous estimates, influenced by the low international interest rates. Thank you for inviting me to present at the Monetary Club of Universidad Finis Terrae. This is a good opportunity to review some recent developments in the Chilean economy, in particular the behavior of the exchange rate, the forex intervention under way, and our monetary policy decisions. But before diving into these issues, let me take a look at some important elements shaping the international scenario, which is where the main risks and tensions facing our economy originated. The international economy The global economy is leaving the Great Recession behind. Its recovery, however, has been heterogeneous and is subject to risks. The developed world still hasn’t fully overcome the negative effects of the crisis, while emerging markets are currently in a strong growth path. Despite they did not commit the excesses of their advanced counterparts; they suffered the effects of the crisis. Overall, the magnitude of the impact on growth in emerging economies was milder than it could have been expected based on recent history, and emerging economies were even able to recover quickly and strongly (figure 1). The good performance of emerging economies is grounded on their macroeconomic policy schemes. These have evolved and improved over time, partly because lessons have been learned from numerous previous shocks, which originated in macroeconomic and financial imbalances. These schemes pursue low, stable inflation, healthy public finances, strong and well regulated financial systems and realistic exchange rates. Of course policies vary from one country to another, but their basic principles are shared. In Chile, a fiscal policy that saves during good times, an autonomous central bank that conducts monetary policy under an inflation targeting regime and a floating exchange rate, were key elements to successfully work its way out of the crisis. Furthermore, the country has a solid, well regulated financial system that does not allow for many of the operations that dragged some economies to their