Recent theoretical approaches on target zones for the exchange rate show that the advantages of this regime (less volatility of the exchange rate compared to a floating one, and the existence of some scope for monetary policy, compared to a fixed exchange rate regime) rely on the credibility of the Central Bank to support the band. This work focused on the analysis of the functioning of the present Chilean regime, in the light of the new theory. It also examines the relationship of this exchange regime and the real exchange rate, monetary and fiscal policies. Since 1989 there has been expectations of a reevaluation on the Chilean currency that have complicated both the exchange rate and the macroeconomic management. These difficulties derived the attempt at targeting the real exchange rate via nominal exchange rate management and a monetary policy oriented to stop expenditure growth with a high interest rate. In the light of this issues a redefinition of the roles of different macroeconomic policies is proposed, specifically, the implementation of an active fiscal policy directed towards a more effective control of aggregate spending (and, therefore, of the real exchange rate). In this context a considerable degree of credibility can be obtained and this will bring about less volatility of the exchange rate and increased flexibility of the monetary policy.
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Article provided by Instituto de Economía. Pontificia Universidad Católica de Chile. in its journal Cuadernos de Economía.
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