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Coping With Chile’s External Vulnerability: A Financial Problem

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  • Ricardo Caballero G

Abstract

With traditional domestic imbalances long under control, the Chilean business cycle is driven by external shocks. Most importantly, Chile’s external vulnerability is primarily a financial problem. A decline in the Chilean termsof- trade, for example, is associated to a decline in real GDP that is many times larger than one would predict in the presence of perfect financial markets. The financial nature of this excess-sensitivity has two central dimensions: a sharp contraction in Chile’s access to international financial markets when it needs it the most; and an inefficient reallocation of this scarce access across domestic borrowers during external crises. In this paper I characterize this financial mechanism and argue that Chile’s aggregate volatility can be reduced significantly by fostering the private sector’s development of financial instruments that are contingent on Chile’s main external shocks. As a first step, the Central Bank or IFIs could issue a benchmark instrument contingent on these shocks. I also advocate a countercyclical monetary policy but mainly for incentive —that is, as a substitute for taxes on capital inflows and equivalent measures— rather than for ex-post liquidity purposes.

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Bibliographic Info

Article provided by Central Bank of Chile in its journal Economía Chilena.

Volume (Year): 5 (2002)
Issue (Month): 1 (April)
Pages: 11-36

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Handle: RePEc:chb:bcchec:v:5:y:2002:i:1:p:11-36

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References

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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1.
  3. Gylfason, Thorvaldur & Zoega, Gylfi, 2001. "Natural Resources and Economic Growth: The Role of Investment," CEPR Discussion Papers 2743, C.E.P.R. Discussion Papers.
  4. J. David Cummins & David Lalonde & Richard D. Phillips, 2000. "The Basis Risk of Catastrophic-Loss Index Securities," Center for Financial Institutions Working Papers 00-22, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  6. Kenneth A. Froot, 1999. "Introduction to "Financing of Catastrophe Risk, The"," NBER Chapters, in: The Financing of Catastrophe Risk, pages 1-22 National Bureau of Economic Research, Inc.
  7. Andrea Tokman Ramos, 2002. "Is Private Education Better? Evidence from Chile," Working Papers Central Bank of Chile 147, Central Bank of Chile.
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Cited by:
  1. Jeffrey Frankel, 2011. "A Solution to Fiscal Procyclicality: the Structural Budget Institutions Pioneered by Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 14(2), pages 39-78, August.
  2. Lane, Philip R, 2003. "Business Cycles and Macroeconomic Policy in Emerging Market Economies," International Finance, Wiley Blackwell, vol. 6(1), pages 89-108, Spring.
  3. Francisco Rosende R., 2002. "El Desafío del Crecimiento Económico en Chile," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 5(1), pages 83-88, April.
  4. Olivier Jeanne, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," IMF Working Papers 03/177, International Monetary Fund.
  5. César Calderón & Roberto Duncan & Klaus Schmidt-Hebbel., 2010. "Institutions and Cyclical Properties of Macroeconomic Policies in the Global Economy," Documentos de Trabajo 372, Instituto de Economia. Pontificia Universidad Católica de Chile..
  6. repec:idb:brikps:31178 is not listed on IDEAS
  7. Daniel Esteban Osorio Rodíguez & Mauricio Avella Gómez, . "The Cyclical Behavior of External Indebtedness: The Case of Foreign and Domestic Banks in Colombia," Borradores de Economia 345, Banco de la Republica de Colombia.
  8. Alicia García Herrero & Javier Santillán & Sonsoles Gallego & Lucía Cuadro & Carlos Egea, 2002. "Latin American Financial Development in Perspective," Banco de Espa�a Working Papers 0216, Banco de Espa�a.
  9. Alejandro Micco & Ugo Panizza, 2005. "Bank Concentration and Credit Volatility," Working Papers Central Bank of Chile 342, Central Bank of Chile.
  10. Daniel Esteban Osorio Rodríguez & Mauricio Avella Gómez, 2005. "The Ciclical Behavior Of External Indebtedness: The Case Of Foreign And Domestic Banks In Colombia," BORRADORES DE ECONOMIA 003571, BANCO DE LA REPÚBLICA.

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