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Reaching One-Digit Inflation: The Chilean Experience

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  • Vittorio Corbo

    ()
    (Pontificia Universidad Católica de Chile)

Abstract

The main purpose of this paper is to analyze the process by which Chile was able to reduce inflation during the 1990s. In this period inflation was gradually reduced from close to 30% per annum in 1990 to only 6% in 1997. The paper concludes that three factors were important in helping to accomplish this performance. First, the independent Central Bank and its tough actions early on -to convey the message that it was ready to stand behind its mandate (to reduce inflation)- helped to shape inflationary expectations and in the process it led to lower wage inflation and ultimately a lower path for core inflation. Second, a restrictive monetary policy, and the foreign exchange intervention policies associated with it, resulted in a trajectory of the nominal exchange rate much below what would have been observed under a PPP rule adjusted for differences in productivity. This result was reinforced by the low credibility of the band reflected in the effect of the location of the exchange rate within the band on the observed rate. Third, the higher rate of growth of labor productivity, given the wage equation, resulted in a lower rate of growth of unit labor cost than otherwise. From these three effects the first effect, the enhanced credibility of the new policy operating through the formation of inflation expectations, was found to be the most important factor behind the success in reducing inflation rate.

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Bibliographic Info

Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

Volume (Year): I (1998)
Issue (Month): (November)
Pages: 123-163

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Handle: RePEc:cem:jaecon:v:1:y:1998:n:1:p:123-163

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  1. Fischer, Stanley, 1988. "Real Balances, the Exchange Rate, and Indexation: Real Variables in Disinflation," The Quarterly Journal of Economics, MIT Press, vol. 103(1), pages 27-49, February.
  2. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  3. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  4. Stanley Fischer, 1984. "Real Balances, the Exchange Rate and Indexation: Real Variables in Disinflation," NBER Working Papers 1497, National Bureau of Economic Research, Inc.
  5. Paul Krugman, 2000. "Currency Crises," NBER Books, National Bureau of Economic Research, Inc, number krug00-1, July.
    • Paul R. Krugman & Kenneth S. Rogoff & Stanley Fischer & William J. McDonough, 1999. "Currency Crises," NBER Chapters, in: International Capital Flows, pages 421-466 National Bureau of Economic Research, Inc.
  6. Bruno, M., 1991. "High Inflation and the Nominal Anchors of an Open Economy," Princeton Studies in International Economics 183, International Economics Section, Departement of Economics Princeton University,.
  7. Sebastian Edwards, 1996. "A Tale of Two Crises: Chile and Mexico," NBER Working Papers 5794, National Bureau of Economic Research, Inc.
  8. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  9. Bruno, Michael, 1978. "Exchange Rates, Import Costs, and Wage-Price Dynamics," Journal of Political Economy, University of Chicago Press, vol. 86(3), pages 379-403, June.
  10. Sebastian Edwards, 1993. "Exchange Rates, Inflation and Disinflation: Latin American Experiences," NBER Working Papers 4320, National Bureau of Economic Research, Inc.
  11. Hargreaves, Colin P. (ed.), 1994. "Non-Stationary Time Series Analysis and Cointegration," OUP Catalogue, Oxford University Press, number 9780198773924, September.
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