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Fiscal and Monetary Policy Rules: The Recent Chilean Experience

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  • Macarena García
  • Pablo García
  • Bernardita Piedrabuena

Abstract

This paper describes monetary and fiscal rules used in Chile in recent years. On monetary policy rules, we present both the framework for monetary policy rate assumptions that guide the construction of inflation and growth forecasts, as well as the broad characteristics of Taylor-Type Rules that reflect recent monetary policy actions. The role of the assumptions on the neutral policy rate as well as issues as what inflation index or time horizon to consider are included in the discussion. On fiscal rules, this paper presents the structural balance methodology used by the Chilean public sector since 2001. This rule implies that expenditures should evolve according to the dynamics of structural fiscal income, which is consistent with full employment and a long-term copper price. The key assumptions underlying the trend GDP growth and the long-term copper price are not set in a discretional way but rather follow the recommendations of two panels of independent experts. We conclude with a positive assessment of the recent Chilean experience with monetary and fiscal policy rules. This positive assessment is driven by the prominent role of monetary policy as the stabilizing macroeconomic instrument under a credible inflation targeting regime, and the avoidance of pro cyclical fiscal policies. In spite of tumultuous external conditions between 1999 and 2003, the Chilean economy managed to sustain positive rates of growth, record-low domestic interest rates and sovereign spreads, stable external public debt, as well as low inflation. The recent upswing in 2004 and 2005 has been accompanied by a smooth normalization of monetary conditions and a substantial improvement in fiscal balances.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 340.

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Date of creation: Dec 2005
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Handle: RePEc:chb:bcchwp:340

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  1. Eric Parrado & Andrés Velasco, 2001. "Alternative Monetary Rules in the Open-Economy: a Welfare-Based Approach," Working Papers Central Bank of Chile 129, Central Bank of Chile.
  2. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  3. Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One Decade of Inflation Targeting in the World: What Do We Know and What Do We Need to Know?," NBER Working Papers 8397, National Bureau of Economic Research, Inc.
  4. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, vol. 58(2), pages 867-894, 04.
  5. Schmidt-Hebbel, Klaus & Tapia, Matias, 2002. "Inflation targeting in Chile," The North American Journal of Economics and Finance, Elsevier, vol. 13(2), pages 125-146, August.
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