Evolution of a Small Open Emerging Economy's External Vulnerability: Evidence for Chile

The increase in global economic volatility due to the ongoing crisis in developed countries and its spillovers to the rest of the world has brought renewed relevance to external shocks as a source of business cycles in emerging market economies. This paper analyzes changes in the impact of external shocks in Chile since the 1990s. A novel aspect of our analysis is the use of structural vector autoregressions with time-varying parameters in the context of a small open emerging economy such as Chile. Our main finding is that external shocks have had smaller effects on local economic output at relevant policy horizons after the 1990s. The timing of the estimated changes coincides with major monetary and fiscal policy reforms conducted around 1999-2001, suggesting that those reforms have played an important role in isolating the Chilean economy from external shocks since that time.