Centro Argentino de Estudios Internacionales WP 19

8/6/2019 Centro Argentino de Estudios Internacionales WP 19

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1Todos los derechos reservados. - Pg

Working paper # 19Programa de Economa Internacional

The Republic of Chile

Against the Gods:a counter-cyclical country in Latin America(Presented to the World Bank on April 16 th 2009)

CAEICentro Argentino

de EstudiosInternacionales

byMara Beln Avellaneda KanttDillon CohenClara Martin


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Against the Gods:A counter-cyclical country in Latin America

Por Mara Beln Avellaneda Kantt, Dillon Cohen y Clara MartinEconoma Internacional

Executive SummaryThe papers focus is the description and analysis of the economic policy in the Republic of Chile,together with a comparison against Ireland. It includes a country snapshot with the description ofmain economic indicators, and a review of its fiscal policy, monetary policy and external balances.We found that the country is still very vulnerable to the economic downturn given its dependence oncopper prices, the external sector and foreign sources of financing for the private sector. However,the government is trying to apply a counter-cyclical policy to buffer the effects to the crisis. Wecompared the case of Chile to the case of Ireland and conclude that both countries are exposed to

risks related to their high dependence on the foreign sector. Nonetheless, Chilean authorities havemanaged their finances much better during the bonanza, which amplifies their margin of actionstowards policy options. The case of Ireland is extremely worrisome, particularly due to the position ofthe banking sector, the direct exposure to the housing bubble and the mismanagement ofgovernment finances. Our paper concludes with a brief analysis and some recommendations focusedon: (a) current risks associated to both countries; (b) the application of the counter-cyclical approach;(c) some common risks associated to monetary expansion and fiscal expansion. The paper waspresented on April 16th to the World Bank. We departed from a logic that presented these countriesas Heaven in Hell (Chile) and Hell in Heaven (Ireland) to state that the first was located in a muchunstable region. However, the real conclusion after this analysis is that Latin American countrieshave learned from the past, and therefore have improved their fiscal sustainability by prudent policy

making. On the other hand, the fiscal deterioration in Europe is extremely worrisome and can cause acollapse of several economies if the financial crisis continues.


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TABLE OF CONTENTS

CONCEPTUAL FRAMEWORK

COUNTRIES RATIONALE

SECTION 1: The Republic of Chile

1.a. COUNTRY SNAPSHOT

1.a.i MACROECONOMIC INDICATORS & TRENDS

1.b. RISK ANALYSIS

1.b.i FISCAL POLICY & DEBT DYNAMICS: The Counter-cyclical approach

1.b.ii. MONETARY POLICY & THE BANKING SECTOR

1.b.iii. THE EXTERNAL SECTOR & BALANCE SHEET

SECTION 2: Chile versus Ireland, comparing heaven in hell and hell in heaven

2. CHILE VERSUS IRELAND: Compared through economic indicators

2.a.i. GROSS DOMESTIC PRODUCT

2.a.ii. CAPITAL ACCOUNT AND CURRENT ACCOUNT2.a.iii. FOREIGN INVESTMENT COMPOSITION

2.a.iv. GOVERNMENT FINANCE AND TAX POLICY

2.a.v. CHILE VERSUS IRELAND: BANKING SECTOR

2.b. MAIN EFFECTS OF THE CURRENT SHOCKS

2.b.i. COMMON EFFECTS OF THE SHOCK

2.b.ii. DISPARETE EFFECTS OF THE SHOCK

2.c. EURO PER VERSUS FLOATING CHILEAN PESO

SECTION 3

3. PUBLIC POLICIES TO BUFFER THE EFFECTS OF THE CRISIS

CONCLUSIONS

POLICY ANALYSIS AND RECOMMENDATIONS


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CONCEPTUAL FRAMEWORK

Latin America and emerging countries in general have been epicenters of several financial

crises associated with external factors and endogenous vulnerabilities. The current crisis, where the

strongest economy in the world is more an emerging country than ever, holds even further challenges

to policy makers. In a global environment characterized by uncertainty and volatility, some tools of

analysis may be helpful to foresee vulnerabilities and reduce the impacts of macroeconomic shocks.

The conceptual framework used in this paper helps us to focus on external threats such as

shrinking commodity prices (Reinhart and Reinhart, 2008), contagion (Calvo and Reinhart, 1996),

and sudden stops (Calvo, 1998); as well as on internal threats such as balance sheet vulnerabilities

(Allen et al, 2002; Calvo et al, 2002) that may lead to liquidity constraints and severe reductions in

output (IADB, 2005; Mendoza and Terrones, 2008). It also allows us to understand policy tools,

including inflation targeting (Frankel 2007) and fiscal management and debt (Reinhart and Reinhart,

2008, IADB, 2007) that may buffer the effects of global downturns.

COUNTRIES RATIONALE

During the past decade both Irelands and Chiles economic models have been praised.

According to many economists they were among the most successful emerging economies. They

improved their institutions and opened their markets to globalization. Following this main stream

thought we tried to analyze what these countries have in common. However, we found that they have

more differences than commonalities. These distinctions have positioned both countries dissimilarly

to face an economic downturn. In this sense, their policy options diverge. In general, Chiles

macroeconomic indicators and fiscal dynamics are in better shape than Irelands. Nonetheless we

believe that the most important threats for these economies are a decrease in exports (particularly in

the case of Chile given the lack of economic diversification and the strong dependence on copper)

and credit constraints. In the case of Ireland, we foresee further problems associated to the banking

system and portfolio investment outflows.

SECTION 1: The Republic of Chile


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This section provides extensive data on the focus country, Chile. It gives a description of the

initial and current situations. Also, it addresses most relevant changes in fiscal and monetary policies.

Finally, the section presents a description of the shock in the external sector and the effects for the

economy. Most projections are based on Central Banks data.

1.a. COUNTRY SNAPSHOT

The Republic of Chile is located in South America. It is a small open economy with upper

middle income. The GNI per capita is $8,350, however the countrys income distribution is highly

unequal (Gini coefficient is 54.9). The total population is approximately 16.6 million. Chiles main

export is copper (57% of total exports) and 40% of its imports come from oil, fuels and food. This

implies a high dependence on commodity markets (Figure 1). The economic diversification of the

country is meager. Even if there are policies oriented towards export diversification (like creating a

country brand) most export goods do not have relevant value added.

Chile has been a star in Latin America due to its credible institutions and the soundness of

both fiscal and monetary policies. However, the country has vulnerabilities to manage. In fact, Chile

experienced a banking crisis from 1981-84 that in relative terms had a cost perhaps comparable to

that facing the United States today. The Chilean Central Bank acted quickly and decisively in three

ways to restore faith in the credit markets. It restructured firm and household loans, purchased

nonperforming loans temporarily, and facilitated the sale or liquidation of insolvent financial

institutions1. In 1989 it suffered from a huge outflow of capital (two standard deviations from the

mean in monthly flows) that affected its GDP, in other words, a sudden stop. Annual growth fell to

3.2% in 1998 and then to -1% in 1999, a full 8% below the average growth rate of the previous 10

years.2 In that period, spreads for Chile increased 50% in 1998 and 100% in 1999.

The present global downturn represents new challenges to policy makers. Last year, the

global financial crisis created a dilemma for the current administration: they could either maintain the

1 CRS Report to Congress. The U.S. Financial Crisis: Lessons From Chile. J. F. Hornbeck. September 29th2008.2Following the negative external shock, the Central Bank of Chile (CBCh) set out to minimize the nominal devaluation

and rein in the current account deficit, by implementing a contractionary monetary policyAt the same time, the CBChintervened in the foreign exchange market selling international reserves which fell from US$18 billion in 1997 to closeto US$15 billion in 1999. This behavior is somewhat typical of economies that exhibit fear-of-floating a reluctanceto let the exchange rate play the stabilizing role suggested by traditional open-economy models (see Haussman, Panizzaand Stein (2001), and Calvo and Reinhart (2002)). http://repec.org/esLATM04/up.13766.1081986571.pdf


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mandated fiscal surplus and the inflation targeting schedule or implement a more flexible fiscal policy

together with monetary easing. The government has chosen the latter option by executing a counter-

cyclical fiscal policy, which is new for Latin American countries.

1.a.i MACROECONOMIC INDICATORS & TRENDS

The Republic of Chiles growth trends are consistent and highly correlated to global patterns

(Figure 2). During the bonanza the country experienced an increase in growth rates while in the

present downturn the country is suffering from a contraction of GDP and GDPs main components,

particularly investment (Figure 3). Last November, Chile's economic activity index fell to its slowest

monthly pace in nearly 7 years (Figure 4). Consistent with trends in growth, unemployment is

increasing (Figure 5).

1.b. RISK ANALYSIS

1.b.i FISCAL POLICY & DEBT DYNAMICS: The Counter-cyclical approach

The fiscal policy framework is given by the Fiscal Rule3 (see Annex 2 Box 1). The rule was

established in 2000 by President Ricardo Lagos. It was originally based in providing a structural

surplus of 1% of GDP. Last year it was lowered to 0.5% of GDP. The continued savings from the

government and copper windfalls were accumulated in two Sovereign Wealth Funds created in 2006.

These two funds, set up with the promulgation of the Fiscal Responsibility Law, are the Economic

and Social Stabilization Fund (ESSF), which is to provide funding for public education, health, and

housing initiatives; and the Pension Reserve Fund (PRF), which is to provide funding for the

government's pension obligations and help pay for the projected increase in the minimum pension

benefit and take-up rate.4

Over the last years the government applied its fiscal policy and debt management

consistently (Figures 7, 8, 9 and 10). However, as a result of the severity of the crisis, particularly on

the private sector, which owes 80% of the total foreign debt, the administration has decided to

implement a robust Stimulus Package that implies a fiscal deficit of 2.9% of its GDP. The decision

3 See Frankel, Jeffrey. (2007)4 http://www.imf.org/external/pubs/ft/survey/so/2007/car1126b.htm


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aims to (a) increase productive capacity by assisting the private sector whose dependence on

international financing sources increased during the past few years (Figure 7); (b) sustain

employment levels; and (c) strengthen domestic demand and help poorer families by a direct subsidy

of $40.000 Chilean pesos called Subsidio nico Familiar (SUF). The plan includes tax rebates,

subsidies and a $1 billion capitalization for state copper giant and No.1 global producer, Codelco 5, to

underpin its investment plans. According to the announcement the financing will come from the

Economic and Social Stabilization Fund (ESSF). The Ministry of Economy estimated that the plan will

generate 100,000 jobs directly. In addition, the government is evaluating issuing a $1 billion

sovereign bond to set a reference for the private sector. It is possible that the government has

delayed this option as a consequence of the increase in spreads, particularly in light of Codelcos

recent bond issuance.

1.b.ii. MONETARY POLICY & THE BANKING SECTOR

The monetary policy framework pillar is given by an inflation targeting scheme. The Central

Bank target was set at a 3% level of inflation and within a -/+ tolerance of a 1% band. Last years

inflation pushed interest rates up to 8.25%. Amid the global crisis the Central Bank has slashed rates

by a surprising 600bps in just three months to 2.25%. The sharp economic slowdown will

dramatically decrease inflation this year (Figures 11, 12). Even if the Central Bank is pumping

money into the system, the policy seems consistent with the level of reserves and the decrease in

aggregate demand and credit (Figures 12, 13, 14).

It is important to notice that in Chile a traditional banking model with a commercial orientation

has prevailed, which has reduced the exposure of the banking sector to the crisis. Also as Glaeser et

5Codelco: The Law Decree 1,350 of 1976 created the Corporacin Nacional del Cobre de Chile, Codelco, conceived as a

mining, industrial and commercial company owned by the Chilean State. Seven members of its Board are named by thePresident. The Board is chaired by the Secretary of mining. Workers also participate in the Board. CORFO supports thegoals of the company and provides guidance and help.


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al. suggest agreater elasticity of housing supply contributed to limit the increase in housing prices in

Chile, preventing the creation of a bubble. The ways in which mortgage loans and related collateral

securities are granted also contributed to avoid an unreal increase in prices which could have lead to

speculation. Notwithstanding, there are still credit constraints specifically related to access to foreign

financing.

Regarding non-performing loans, we found relatively satisfactory ratios, at least in most

important banks. The overall Non-Performing Loans (NPL) to Total Loans (TL) ratio for the banking

system is 3% (Figure 41). Chilean banks have started tightening lending policies in response to a

reduction in the amount of dollar credit being given by U.S. banks. Also, the export sector has been

affected by banks reducing the repayment periods on dollar-denominated loans. Local banks have

also tightened lending risk criteria and are seeking credit from new sources, like Asia. De Gregorio of

the BIS commented,: Last September, liquidity tensions grew substantially around the world, as well

as in Chile. This led the Board to bring the reserve purchase program to an end when almost 6 billion

dollars had been accumulated, and the country had reached quite a comfortable international liquidity

position, which would enable it to mitigate any possible sudden stop of capital flowsin view of the

worsening of liquidity problems, the Bank announced the supply of liquidity in pesos and dollars

through repos and swaps. Later on, in October, the range of eligible collaterals was broadened and

the dollar swap program was extended for six months. Then, in December, an extension for all of

2009 was announced for the repos and swaps program, and the range of eligible collaterals wasbroadened further. The purpose of these measures was to align market rates with the Monetary

Policy Rate and to alleviate foreign currency liquidity tensions6.

1.b.iii. THE EXTERNAL SECTOR & BALANCE SHEET

During the bonanza Chiles current account remained positive. However, in the present the

situation has been reverted and Chile has become a net borrower from the rest of the world (Figure

15). The current account deficit is expected to widen to 5% of GDP. There has been a positive

relationship between the price of copper and the increase in foreign reserves. This trend was

completely reversed by 2008 showing that the government wanted to accumulate more reserves to

cushion the drop in copper prices (Figure 16).

6 De Gregorio, Jos. BIS report: Chile and the global recession of 2009. March 2009


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It is important to mention that the Chilean economy does not have many price distortions,

and therefore changes in international prices of goods and services are transmitted at very fast pace.

The terms of trade have worsened given that the price of exports has decreased relative to the value

of imports (Figures 17, 18). Nevertheless, the decrease in oils and fuels prices will aid to increase the

domestic production capacity. Despite the use of reserves, the FX has been depreciating; the actual

spot price is 623.01 pesos per USD (Figure 19). The latter has a dual effect in the economy; on the

one hand the depreciation will buttress exports. On the other hand, it may complicate the situation for

corporations with dollar denominated debts. Overall, the stock of international reserves and assets

accrued in the economic and social stabilization fund (FEES) have permitted the Central Bank and

the State to take a number of measures intended to provide liquidity in foreign currency to local

agents, through a program of currency swaps and dollar deposits in domestic banks7.

SECTION 2: Chile versus Ireland, comparing heaven in hell and hell in heaven

2. CHILE VERSUS IRELAND: Compared through economic indicators

This section compares most relevant macroeconomic indicators in both economies. Itprovides data to show main threats as well as vulnerabilities. Also it addresses the common effects of

the current crisis such as decrease in exports and credit constraints, as well as dissimilar effects. The

lasts, include Chiles dependency on copper prices and Irelands problems in the banking system, the

housing bubble and potential capital outflows.

2.a.i. GROSS DOMESTIC PRODUCT

In this section we discuss GDP in both countries in three terms: GDP Growth, GDP

dependence on the Foreign Sector and Composition of Internal Demand.

In terms of GDP growth both countries are strongly affected by the financial crisis being

transmitted to the real sector in Chile in the form of global demand contraction and in the form of

construction crash and deep banking crisis in Ireland.

7 Central Bank. Financial Stability Report. 2Q 2008


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10Todos los derechos reservados. - Pg10

Chiles GDP growth (% real change pa) is estimated to fall to 3.4%. In fact in the last quarter

of 2008 GDP growth was only 1.1% and is forecast to grow only 0.4%.in 2009. This decline in GDP

growth is basically due to: (i) The open nature of the Chilean Economy, where exports contracted

55.7% (mainly concentrated in copper). Although imports also declined 25.5% in 2008, it did not

occur until November due to the decrease in consumption and the depreciation of the Peso.

Consequently, the participation of Net Exports over the total GDP severely declined. (ii) The year-

over-year growth of the Internal Demand (ID) was stable in 2008, however Internal Demand

contribution to GDP growth is forecasted to decrease a 2.8% in 2009 mainly due to a contraction of

Fixed Investments around 14.4% (Figures 23 and 24).

Ireland is experiencing a very severe recession GDP fell 2.7% in 2008 and a 6.2% decline

is expected in 2009. The economy has fallen off a cliff as the Irish Finance Minister said. The

decreased is mainly due to (i) the decline in Exports, which represents around 80% of GDP. Though

it is compensated with a decline in imports, the large percentage of dependence of GDP on exports

(around 80% versus 46% in Chile) make the country more vulnerable to the external sector a

problem which has been compounded by the devaluation of sterling (the UK represents a 18% of

total exports in 2007) and the strengthening of the Euro versus the USD (the US represents 17.6% of

total exports in 2007). (ii) The crash of the construction sector is one of the main drivers of

decreasing internal demand, leading to a 5.1% decrease in Fixed Investment in 2008. (Figures 22, 23

and 24).

To conclude although both countries are affected by the crisis, Ireland, in terms of GDP

composition, is more vulnerable.

2.a.ii.CAPITAL ACCOUNT AND CURRENT ACCOUNT

Chile and Ireland profiles are absolutely opposite; Chile was a Net Lender country in 2007

(9% of Nominal GDP) with an estimated Current Account around zero in 2008, while Ireland runsconsistently negative Current Account balance from minus 0.8% to minus 7.88% from 2004 to 2007,

and estimated to be around minus 7% in 2008.

Both Chile and Ireland have positive Balances of Goods and Services (25% and 14% of GDP

respectively in 2007). They also have negative Net Income Balances of around 20%, but in the case


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of Ireland it is not compensated by the Net Balance of G&S turning up into a Balance of G&S and Net

Income around negative 6% of GDP in 2007 compared with a positive 5% in Chile (Figures 25, 26 &

27). The problem is more severe for Ireland given that the negative current account is financed by

mostly by debt.

2.a.iii. FOREIGN INVESTMENT COMPOSITION

Both countries receive great amounts of Foreign Investment (FI), but it is higher in Ireland,

not only in absolute terms but also in terms of GDP with 3.1 and 3.6 times GDP in 2006 and 2007,

while Chile was the recipient of 0.1 and 0.3 times GDP. (Figures 28 & 29). This difference is due to

greater portfolio investments, mostly in equity, received by Ireland, which represents from 2005 to

2007 around 60% of the total FI, adding around 30% of other investment in 2005 and 2007 in thebanking sector (this point should be subject to further study in following reports) (Figure 29). This high

concentration of portfolio investments, subject to easy runs of capital, makes Ireland more vulnerable

to liquidity shocks.

2.a.iv. GOVERNMENT FINANCE AND TAX POLICY

In terms of public debt, though Chile is in an extraordinarily good position, approximately 4%

of GDP, Ireland is not in a bad position, with 32% of GDP, particularly if compared with the averageof its European partners, 40%. Another mitigating factor is that most of both countries Public Debt is

in domestic currency.

However, Irelands property bubble has caused a collapse in tax revenues (highly dependent

on stamp duty on property sales) and the budget has gone from balance in 2007 to 8% deficit in 2008

and a forecast of 12% deficit for 2009. Moreover the cost of bailing out the financial system put in

greater danger the government budget, as a consequence the spread over the German Bond

reached 282 bps in March 2009.

On the other side, Chile showed a 5.3% surplus in 2008, in spite of private mining taxes

decline of 65.9%. However the forecast 2009 deficit of 3% is to be financed by ESSF and new debt.

As a consequence, while Chile will be able to run a 2.8% of GDP stimulus package in 2009, Ireland is

set to introduce an emergency budget in April 7 to reduce the deficit by 6.1 Billion USD, or 2% of


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GDP mainly by increasing taxes. To conclude, Chile is in one of the most privileged positions to

face the financial crisis while Ireland will have to focus its efforts on the financial sector bail out while

pushing the real economy (Figure 30). Also, Chiles fiscal management in the past few years has

allowed the implementation of a counter-cyclical policy that should buffer the crisis, while Ireland will

apply a pro-cyclical policy by increasing taxes and cutting spending. Finally, even if the fiscal situation

for Ireland seems to be manageable in the short run it becomes less sustainable on a long term

basis.

2.a.v. CHILE VERSUS IRELAND: BANKING SECTOR

The greater vulnerability of the Irish Central Bank is shown in figure 31. Though Irish

Reserves have slightly increased in 2008, M2 has dramatically increased in the last 5 years, whileChile has maintained a stable ratio M2/R due to great increase in Reserves in the last few years.

The Banking systems clearly differentiate these countries, while Ireland faces a banking

system collapse, (having guaranteed the liabilities of the main commercial banks, nationalized one

and agree to recapitalize others). The Chilean Central Bank had a conservative policy whose

minimum requirements capitalization levels are significantly above the statutory minimum (Basel II)

and tend to exceed levels in other countries.

Regarding foreign liabilities in the banking system, both countries demonstrate a good hedgewith foreign assets and not an extreme currency risk (Figure 32). Besides, though the credit to the

private sector grew at double digit until 2007 for both countries, it has drastically decreased in 2008,

showing the effect of the liquidity crisis (Figure 33).

2.b. MAIN EFFECTS OF THE CURRENT SHOCKS

2.b.i. COMMON EFFECTS OF THE SHOCK

As discussed above in 2.a., we explored the effects the shock was having on GDP growth in

Chile and Ireland. In both countries, the shock has had a severe impact on GDP growth, driving it

from 4.2% to 1.1% in Chile and Irelands falling off a cliff with -2.7% contraction in 2008 and an


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estimated -6.2% contraction forecast for 2009. The main commonality between both economies is the

contraction of the export sector. As we will explain we believe that Chiles high dependence on

copper makes it very vulnerable to decreases in global demand and commodity prices. In the case of

Ireland we focus our attention on the risks associated to capital outflows and financial distress.

2.b.ii. DISPARETE EFFECTS OF THE SHOCK

Chilean Sensitivity to Copper PricesPrior to the shock, the Chilean economy relied on copper for 57% of its GDP. The global

economic shock caused simultaneous decrease in demand worldwide and copper prices went from a

high of $4.00/lb to $1.20/lb. between July 2008 and January 2009. This is illustrated in figures 34

and 35, one and five year copper prices respectively. From the five year chart, it is clear that Chile

has had to manage volatile copper prices in the recent past, but not as volatile as seen in the second

half of 2008. As a result, the value of Chilean exports dropped 24.4% in December 2008 year-over-

year. This was the largest drop in exports in over a decade.

As mentioned above, Chile had planned ahead for this event with the Copper Stabilization

Fund, now transformed into the Economic and Social Stabilization Fund. As a stabilization fund, its

goal is to smooth government spending when copper revenues go down. (Figures 34, 35)

Ireland and the Collapse of the Housing Bubble

The collapse of Irelands housing bubble has left a 18 billion structural gap in the budget

due to the loss of the stamp duty on property taxes. According to some estimates, Irish housing

prices fell 9.7% - not quite as much as in the U.S., where prices fell 19% in January year-over-year.

Irish residential loan growth fell to 4.9% in February 2009, a 23 year low.


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The dangers of the Irish housing bubble were foreseen by the Central Bank, which warned in

2006 that private sector lending was overheating, led by the growth in the housing market.

2.c. EURO PER VERSUS FLOATING CHILEAN PESO

Chile presents a quasi-perfect correlation between the nominal exchange rate and the real

effective exchange rate (appreciated both at 30% since 2000), maintaining Terms of Trade (ToT)

relatively stable in the last years (Figure 40). On the other hand, Ireland is suffering the

consequences of an overly strong Euro. While Euro has appreciated 37% since 2000 in nominal

terms, in terms of effective real exchange rate, it has depreciated 41%. This fact is producing a

growing ToT and negatively affecting the competitiveness of Ireland. The fact that 36% of exports areto the US and the UK, both with depreciated currency is running against Ireland, whose dependency

on non-Euro Countries is greater than many of European countries (Figure 41).

The FX results are extremely important when balancing export competition and debt

dynamics. Some people have claimed that Ireland should leave the Euro and let the Irish pound

depreciate in order to increase its competition through exports. However, we have to consider that

Irish external debt is mostly denominated in Euros. Hence, if there were a depreciation of the

currency, dollarized liabilities would become unsustainable which might lead to a default. The latterwill create a further crisis in confidence and probably a speculative attack on the currency which

again will weaken the fiscal situation. 8

2.d.ii.a. THE CENTRAL BANK OF CHILE VERSUS THE EUROPEAN

CENTRAL BANK

The Central Bank of Chile has two main tenets: to set monetary policy in a countercyclicalfashion, in order to reduce output volatility, and to maintain an inflation targeting regime, with a 3%

inflation target for the CPI with allowances of plus or minus 1%.

8 See Calvo, Izquierdo and Talvi on DLD (2002)


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The European Central Bank (ECB) has at the center of its behavior a goal of fighting

inflation, but it does not have an inflation target. It balances inflation-fighting against a philosophy to

maintain output in situations such as today, when Europe faces a global credit crisis and crisis of

demand. (Figures 37, 38, 39)

SECTION 3

This section describes most relevant policies to buffer the effects of the crisis. It covers:

monetary policy, fiscal policy and measures related to the banking system.

3. PUBLIC POLICIES TO BUFFER THE EFFECTS OF THE CRISIS

Policy Chile Ireland

Monetary Expansionary

- Consistently decreased interestrates since December 2008. The totaldecrease in rate was 6.25%, from8.25% to 2%.

Monetary Strategy:

European Central Bank (ECB) respondsslowly to the crisis, at first concerned aboutthe inflation of spring and summer 2008.Later, realizing the seriousness of the creditcrunch, rates were lowered, albeit slowerthan the Fed.

Fiscal Expansionary

-Announced a $4 billion stimuluspackage, financed by windfalls fromcopper revenues and governmentsavings accumulated in SWF.

-The counter-cyclical package isequivalent to 2.8% of GDP andincludes direct support to low incomefamilies, investment in publicinfrastructure, tax cuts and incentivesto the private sector.

-The Government is analyzing thepossibility of borrowing $1 billion fromthe capital markets by issuing bonds.The idea is also setting a parameterfor corporate sector borrowing. It isbelieved that the government will tapthe international markets soon,specially after Codelco (Corporacin

Government Position on FiscalSituation:

Taoiseach Bran Cowen claims he willsubmit a budget as close as possible to adeficit of 9.5% of GDP. Outside analystsforesee a deficit of at least 10.9% of GDP.

Government Pensions:

The Taoiseach imposed an unpopularpension levy on public-service workers, whohad refused to accept the tax. Thisrepresented the end of a thirty-year social

partnership between the government andlabor.

Ratings Downgrade:

On 30 March 2009, S & P downgradedIrelands debt from AAA, the highest rating,to AA+, the next notch down. This willinevitably lead to higher borrowing costs,exacerbating the fiscal deficit. Ireland


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Nacional del Cobre de Chile) priced a$600 million 10 year bond. Thetransaction was priced 537.5bps overUS Treasuries, which implies a slightincrease in the cost of capital.

reached AAA status in 2001.

S & P noted that the fiscal situation willrequire a number of years of sustainedeffort to repair, on a scale greater thanfactored into the governments current

plans.

Banking

System

Measures

The measures to ease the pressureon the banking system include theabolition of stamp duties paid onloans. This tax stands at 1.2% of theprincipal and represents a loss inrevenue for the government of almost$700 million.The banking system will be

particularly hard hit with asset andcredit growth likely to fall both on theback of rising external borrowingcosts and declining domestic demandfor new loans. However, Chilesbanking sector remains strongrelative to other LATAM countries.The direct exposure to the housingbubble and toxic assets has beenlow. The sector is not assophisticated as the European or

American banking systems, hencethe use of derivatives and structuredproducts such as Mortgage-BackedSecurities was fairly limited.Deposits per-capita in Chile are alsothe highest in the region and as suchare vulnerable to a slowdown.In local currency terms, total assets,total loans and total depositsincreased by 22%, 21% and 18%respectively in 2008. The

loan/deposit and loan/GDP ratiosrose until 2Q of 2008.

Large Bank Accused of Fraud:

Anglo-Irish bank was raided in March andthe Irish Financial Regulator is poring overthe boxes of records it confiscated. TheRegulator is considering expanding to bettermonitor Irelands banks.

Ireland Shores Up Two Banks with 7

billion :

Irish Banks are hurting due to theirexposure to the housing sector, and theTaoiseach is leading a 7 billion bailout ofthe two largest banks, Bank of Ireland andAllied Irish, with purchases of preferredstock almost exclusively from funds fromIrelands National Pension Reserve Fund, a19 billion entity created to protect Irelandfrom the problems of an aging population.The banks are expected to pay an 8-9%dividend.


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POLICY ANALYSIS AND RECOMMENDATIONS

This policy analysis focuses: (a) current risks associated to both countries; (b) the application

of the counter-cyclical approach; (c) some common risks associated with monetary expansion and

fiscal expansion.

(a) Both economies are highly integrated into the international economic system. As a

consequence their domestic growth is correlated to global trends. In this context GDP is likely to

contract in Chile and Ireland. Chiles decline in GDP will be driven by a substantial decrease in

exports (since trading partners demand is likely to shrink), a decline in fixed investments due to an

increase in the cost of capital and the reduction of liquidity. The government is trying to buffer the

decline in GDP by a stimulus package that targets both production and demand. Given Chilesdependence on the external sector the most important effect and threat of this crisis will be a

contraction in export together with a decrease in copper prices.

Chiles Current Account position has been positive throughout the last couple of years and

government debts have been reduced. In the case of Ireland, the contraction of GDP is also

associated with a decrease in exports and also the burst of the housing bubble which has

dramatically affected the construction sector. Unlike Chile, Irelands debts have increased

exponentially and its current account deficit has been financed by debt instruments. It is interesting to

notice that few years ago Irelands unrestricted opening to foreign capital outflows was praised by the

public opinion and international officials. However, what used to be a blessing now appears to be a

curse. Liquidity is draining and capital outflows are increasing in a context in which the ratio Reserves

to M2 shows a very vulnerable position. According to our data Ireland is much more vulnerable than

Chile to a sudden stop or a banking crisis.

(b) Chiles counter-cyclical approach appears to be an anomaly within Latin America. Hopefully,

the recent package will help to buffer the most negative effects of the crisis. It is important to highlight

that the package targets both demand and supply. On the demand side they have basically helped

directly most poor families with a subsidy; the latter will buttress consumption given that the

propensity to consume for low income families is higher than the propensity to save, since they need


18/46


to spend their income in basic goods. On the supply side, they have helped the banking system

through tax rebates and also given assistance to small and medium companies. Despite of the

general crisis, Chilean companies that have suffered energy constraints last years will be able to

increase their production since the prices of oils and fuels have gone down. Moreover, Chile is one of

the few Latin American countries that can afford a counter-cyclical package by itself and has the

institutional framework to control expansionary instruments. Unlike other countries that have build

reserves only as a consequence of the bonanza, Chile has a determined policy making and the

selected approach is consistent with its long term strategies. However, most governments policies

are biased towards assisting the export sector. We understand that this strategy is logic due to the

revenues that the sector provides to the whole economy. But we believe that the effects of credits

constraints suffered by small and medium enterprises are being undermined by the authorities.

These companies actually provide employment to the majority of the population. Therefore,supporting their proper operations by providing small lines of credits will diminish social pressures

and job losses. A possible vehicle to provide liquidity could be Banco de Estado.

(c) Finally, we want to underline that even if we agree that stimulus packages are very

necessary in the present situation these tools should not be abused. If fiscal policy is not

accompanied by monetary policy a Crowding-out Effect may take place. A rise in interest rates

caused by the governments increased borrowing in the money market and a resulting decrease in

planned investment. However, an expansionary monetary policy will mitigate that effect in the short

run. In the long run, an expansion of liquidity may lead to inflation. At the same time, fiscal

expansions may pressure towards the appreciation of the local currency which will damage exports

competitiveness. It is crucial for multilateral institutions to have an active and coordinated role to face

this crisis. Not only as lenders of last resort but as agents with the capability to monitor economic

policies and channel them towards long run sustainability.

BIBLIOGRAPHY

ALLEN, MARK, CHRISTOPH B. ROSENBERG, CHRISTINA KELLER, BRAD SETSSER ANDNOURIEL RUBINI, (2002) A Balance Sheet Approach to Financial Crisis, IMF Workingpaper WB/02/210. December 2002.


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CALVO, GUILLERMO A. (1998). Capital Flows and Capital-Market Crises: The Simple Economics ofSudden Stops, Journal of Applied Economics (CEMA), 1(1): 35-54.Reprinted in Guillermo A.Calvo, Emerging Capital Markets in Turmoil: Bad Luck or Bad Policy, Cambridge, MA: MITPress, 2005.

CALVO GUILLERMO A., ALEJANDRO IZQUIERDO, and ERNESTO TALVI (2002). Sudden Stops,

the Real Exchange Rate and Fiscal Sustainability: Argentinas Lessons, NBER WorkingPaper No. 9828. Reprinted in Guillermo A. Calvo, Emerging Capital Markets in Turmoil: BadLuck or Bad Policy, Cambridge, MA: MIT Press, 2005.

CALVO GUILLERMO A. AND CARMEN REINHART, 2002, Fear of Floating Quarterly Journal ofEconomics, 117, no. 2, May, 379-408.

CALVO GUILLERMO, ALEJANDRO IZQUIERDO, and ERNESTO TALVI Systemic sudden stops: therelevance of balance-sheet effects and financial integration. Working Paper 14026.http://www.nber.org/papers/w14026. May 2008.

CALVO, SARA AND CARMEN REINHART, 1996, Capital Flows to Latin America: Is there ContagionEffects? in Private Capital Flows to Emerging Markets, ed. Guillermo Calvo, Morris

GOLDSTEIN AND EDUARD HOCHREITER, eds. Institute of International Economics,Washington, DC. http://mpra.ub.uni-muenchen.de/7124/1/MPRA_paper_7124.pdf

CENTRAL BANK. Financial Stability Report. 2Q 2008

DE GREGORIO, JOS. BIS report: Chile and the global recession of 2009. March 2009

DESORMEAUX, JORGE, KAROL FERNNDEZ AND PABLO GARCA Financial implications ofcapital outflows in Chile: 19982008

FRANKEL, JEFFREY, and ANDREW ROSE (1996). Currency Crashes in Emerging Markets: AnEmpirical Treatment, Journal of International Economics, 41(3/4): 351-66.

----------------------------, 1995, "The Stabilizing Properties of a Nominal GNP Rule," JMCB vol.27, 2,May 1995, 318-34. Experience of and Lessons from Exchange Rate Regimes in EmergingEconomies, Monetary and Financial Integration in East Asia: The Way Ahead, AsianDevelopment Bank, (Palgrave Press) 2004, vol. 2, 91-138.

-----------------------------, CID, Harvard University. Making Inflation Targeting Appropriately FlexibleSouth African Treasury, Pretoria, Jan. 16 &. Stellenbosh University, Jan. 18, 2007

INTER-AMERICAN DEVELOPMENT BANK. 2005. Unlocking Credit. IPES.

----------------------------------------------------------, 2007. Living with Debt. IPES

MENDOZA, ENRIQUE G. AND MARCO E. TERRONES. An Anatomy of Credit Booms: EvidenceFrom Macro Aggregates and Micro Data. IMF Working Paper 08/226; September 1, 2008

REINHART, CARMEN AND VINCENT REINHART, Capital Flows Bonanzas: An Encompassing Viewof the Past and Present, mimeo, June 2008. http://www.nber.org/papers/w14321.pdf .

RODRIK, DANI, AND ANDRES VELASCO (1999), Short-term Capital Flows, NBER Working Paper7364 (also published in Annual World Bank Conference on Development Economics 1999).


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ANNEX: GRAPHS AND TABLES

Figure 1 ________________________________________________________________

General Information

Population 16.6M

GNI per capita is $8,350.00

Gini coefficient 54.9% of Exports from Copper 57%% of Exports from oils, fuels, food 40%Unemployment 7.80%Main Potential Vulnerabilities Decrese in Exports

Further decrease in Copper PricesEnergy managementPrivate Sector IndebtnessUnequal Income DistributionCapital OutflowsBanking Sector CrisisAbuse of fiscal & Monetary policiesCredit ConstrainstPolitical Environment: coming electionsFX variability

Main Strenghts Credible InstitutionsFiscal & Monetary policies soundnessRelatively low cost of capitalInvestment grade rating

Figure 2________________________________________________________________

-2

-1

0

1

2

3

4

5

6

7

0 2 4 6 8 10

Correlation Coefficient= 0.934 & R^2=0.873

Source: elaborated with World Bank's data

%

World Growth Chile's Growth


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Figure 3________________________________________________________________

-5

0

5

10

15

20

25

2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Central Bank of Chile , IFS, Credit Suisse

%

Real GDP Growth

Growth in rea l private Consumption

Growth in real fixed investment

Figure 4________________________________________________________________

Monthly Indicator of Economic Activity (IMACEC)

0.0

1.0

2.0

3.04.0

5.0

6.07.08.0

Feb

May

Agust

Novembe

rFe

bM

ayAg

ust

Novembe

rFe

bM

ayAg

ust

Novembe

rFe

bM

ayAg

ust

Novembe

rFe

bM

ayAg

ust

Novembe

rFe

bM

ayAg

ust

Novembe

r

Source: Central Bank of Chile

Figure 5________________________________________________________________


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Unemployment Rate

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2001 2002 2003 2004 2005 2006 2007 2008 2009


Figure 6________________________________________________________________

-4

-2

0

24

6

8

10

12

2002 2003 2004 2005 2006 2007 2008 '2009F 2010F

Source: Central Bank of Chile, Credit Suisse, EIU

%

General government fiscal balance (% of GDP)

Central government primary fiscal balance (% of GDP)

Figure 7________________________________________________________________


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External Debt as % of GDP

0 20 40 60 80 100 120 140

2008

2006

2004

2002


Gross ED

Public

Private

Figure 8________________________________________________________________

-20

-10

0

10

20

30

2002 2003 2004 2005 2006 2007 2008 '2009F 2010F

Source: Central Bank of Chile, Credit Suisse

%

Central government expenditure (% of GDP)

Gross central government debt (% of GDP, end-year)

Net central government debt (% of GDP, end-year)

Figure 9________________________________________________________________


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Spreads

0

100

200

300

400

500

Jan-99

Dec-99

Nov-00

Oct-01

Sep-02

Aug-03

Jul-04

Jun-05

May-06

Apr-07

Mar-08

Source: Data Stream - Bloomberg

Chile Corporate Bond

Chile Embi GlobalSovereign Bond

Chile Embi GlobalSovereign Bond ChileEx-Codelco

Figure 10_______________________________________________________________

Sovereign Spreads

(basis points)

05.Sep.08Clasificacin Sovereign

Moody's Spread

LT/FC Basic Points

(CSDR)Argentina Argentina (B3 Argentina (B3 Argentina B3 713 713

Brasil Brasil (Ba1) Brazil (Ba1) Brazil Ba1 261 261

Colombia Colombia (Ba Colombia (Ba Colombia Ba1 242 242

Per Per (Ba1) Peru (Ba1) Peru Ba1 225 225

Mxico Mxico (Baa1 Mexico (Baa1 Mexico Baa1 218 218

Chile Chile (A2) Chile (A2) Chile A2 171 171

China China (A2) China (A2) China A2 128 128

Malasia Malasia (A2) Malaysia (A2) Malaysia A2 156 156

Hungra Hungra (A3) Hungary (A3) Hungary A3 162 162

Polonia Polonia (A1) Poland (A1) Poland A1 173 173

Rusia Rusia (Baa1) Russia (Baa1 Russia Baa1 254 254

Sudfrica Sudfrica (Ba South Africa ( South Africa Baa1 264 264


Latin

American

Economies

Other

Investment

Grade

Economies

Chile

Figure 11_______________________________________________________________


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01

2

3

4

5

6

7

8

9

10

2002 2003 2004 2005 2006 2007 2008 '2009F 2010F

Source: Central Bank of Chile and Credit Suisse

%

CPI inflation (% , December over December)

CPI inflation (% change in average index for the year)

Monetary policy reference rate (end-year, %)

Figure 12_______________________________________________________________

010

20

30

40

50

60

70

80

2002 2003 2004 2005 2006 2007 2008 '2009F 2010F


%

Broad money supply (M2, % of GDP)Domestic credit (% of GDP)


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Figure 139_______________________________________________________________

Reserves to M2 ratio

0

1

2

3

4

5

6

2001 2002 2003 2004 2005 2006 2007 2008

Soruce: Central Bank of Chile and IFS

%

Figure 14_______________________________________________________________

February 1-15, 2009

(Monthly average in billions of pesos)

Currency in circulation 2503.56M1 10702.35

Monetary base 4165.58

Central Government and private loans:

Domestic Currency 56969.5Foreign Currency 13989.7


PRIVATE MONETARY AGGREGATES

9The higher the ratio of R/M2 is, the worse the situation, becomes and so the greater the vulnerability. In other words: if

M2 is too high you have printed more money than the amount you may back up with reserves in case of a downturn inyour financial account


27/46


Figure 15_______________________________________________________________

Balance of Payments

-3000

-2000

-1000

0

1000

2000

3000

40005000

I.01

III.01

I.02

III.02

I.03

III.03

I.04

III.04

I.05

III.05

I.06

III.06

I.07

III.07

I.08

III.08

M

Current Account Capital Account

Figure 16_______________________________________________________________

0

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Central Bank of Chile, Data Stream-Bloomberg, Credit Suisse

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

Gross FX Reserves $ Price of Copper


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Figure 17_______________________________________________________________

Terms of trade

0

20

40

60

80

100

120

140160

180

2001 2002 2003 2004 2005 2006 2007 2008 2009


Total

Without

copper

price

effect

Figure 18_______________________________________________________________

-40

-30

-20

-10

0

10

20

30

40

50

2002 2003 2004 2005 2006 2007 2008 2009F 2010F

Source: Central Bank of Chile, INE, Credit Suisse

%

Exports (goods and nonfactor services, % increase in $ value)

Imports (goods and nonfactor services, % increase in $ value)


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Figure 19_______________________________________________________________

-8

-6-4

-2

0

2

4

6

2002

2003

2004

2005

2006

2007

2008

'20

09F

2010F


%

0

100

200

300

400

500

600

700

800

REER (% year-on-year change, annual average)

Exchange rate (CLP per USD, end-year)


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Figure 20______________________________________________________________

Figure 21_______________________________________________________________

IMF

I. Official reserve

assets and

other foreign currency

(approximate market

value) 4

Jan-09

A. Official reserve

assets 23,453.57

(1) Foreign currency

reserves (in convertible

foreign currencies) 23,161.17

(a) Securities 17,322.31

of which: issuer

headquartered in

reporting country but

located abroad

(b) total currency and

deposits with: 5,838.86

(i) other national

central banks, BIS and

IMF 10.3

(ii) banks

headquartered in the

reporting country

of which: located

abroad

(iii) banks

headquartered outside

the reporting country 5,828.56

of which: located in the

reporting country

(2) IMF reserve

position 161.92

(3) SDRs 55.13

(4) gold (including gold

deposits and, if

appropriate, gold

swapped)5 7.08

volume in millions of

fine troy ounces 0.01

(5) other reserve

assets (specify) 68.27

financial derivatives

Total

Up to 1

month

More than 1

and up to 3

months

More than 3

months and

up to 1 year

-1,701.94 -1,061.65 -484.1 -156.2

outflows (-) Principal -1,573.64 -1,061.65 -459.6 -52.4

Interest -128.3 0 -24.5 -103.8

inflows (+) Principal 0 0 0 0

Interest 0 0 0 0

0 0 0 0

390 215 0 175

-4.83 -4.83

-4.83 -4.83

trade credit (-)

trade credit (+)

other accounts payable (-)

other accounts receivable (+)

(b) Long positions (+)

3. Other (specify)

outflows related to repos (-)

inflows related to reverse repos (+)

1. Foreign currency loans, securities, and

deposits 6

2. Aggregate short and long positions in

forwards and futures in foreign currencies

vis--vis the domestic currency (including

the forward leg of currency swaps) 7

(a) Short positions ( - )

II. Predetermined short-term net drains on foreign currency assets (nominal value)

Maturity breakdown (residual maturity)

MEMOITEMS

d) securities lent and

on repo15 461.94

lent or repoed and

included inSectionI -3,981.35

lent or repoed but

not includedin Section

I 0

borrowed or

acquired andincluded

in Section I 0

borrowed or

acquired but not

included inSectionI 4,443.29


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0.000

50.000

100.000

150.000

200.000

250.000

300.000

1998199

9200

0200

1200

2200

3200

4200

5200

6200

7200

8

0.000

2000.000

4000.000

6000.000

8000.000

10000.000

12000.00014000.000

16000.000


FOREIGN LIABILITIES FOREIGN ASSETS

Figure 22_______________________________________________________________


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CHILE: GDP COMPOSITION IN %

Source: Central Bank, forcasted based on Central Banks data

IRELAND: GDP COMPOSITION IN %

Source: European Central BankFigure 23_______________________________________________________________


33/46


CHILE: Internal Demand Composition in %.


IRELAND:Internal Demand Composition in %.



34/46


CHILE: GDP Growth yoy


IRELAND: GDP Growth yoy

Source: European Central Bank

Figure 25_______________________________________________________________


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CHILE. Capital and Financial Accounts and Change in Reserves. MM USD


IRELAND: Capital and Financial Accounts and Change in Reserves. MM USD



36/46


CHILE and Ireland CA over Nominal GDP

Source: Central Banks

Figure 27_______________________________________________________________

CHILE and Ireland Balance of Payment Composition in 2007 over GDP

Sources: Central Banks, IFS

Figure 28_______________________________________________________________


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.CHILE and Ireland New FI times Nominal GDP

Source: IFS


38/46


Figure 29_______________________________________________________________

CHILE. FI (MM USD)


IRELAND. FI (MM USD)



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Figure 30_______________________________________________________________

CHILE and Ireland Deficit % over GDP and Total Debt % over GDP

Source: IFS

Figure 31_______________________________________________________________

CHILE and Ireland : M2 and Reserves

Source: IFS


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Figure 32_______________________________________________________________

CHILE and Ireland: Foreign Liabilities in the Bank Sector

Source: IFS

Figure 33_______________________________________________________________

CHILE and Ireland: Claims of the Banking sector over the Private sector

Source: IFS


41/46


Figure 34_______________________________________________________________

Source: Kitco.

Figure 35_______________________________________________________________

Source: Kitco


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Figure 36_______________________________________________________________

Irish versus German 10 Year Bond Yields

Source: EIU

Figure 37_______________________________________________________________

Spread between Irish and German 10 Year Bonds

Source: EIU


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Figure 38_______________________________________________________________

Chilean and U.S. 10 Year Bond Yields

Source: EIU

Figure 39_______________________________________________________________

Spread Between Chilean and U.S. 10 Year Bonds

Source: EIU

Figure 40_______________________________________________________________


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CHILE: Nominal Exchange Rate versus Real Efective Exchange Rate and ToT


Figure 41_______________________________________________________________

IRELAND: Nominal Exchange Rate versus Real Efective Exchange Rate ans ToT


Figure 42_______________________________________________________________


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No-Performing

Total Loans Loans (90>days) NPL/TL

Banks in Chile 60,230,176 1,146,458 2%

Bice 2,035,227 18,818 1%

Bilbao Vizcaya Argentaria, Chile 5,172,746 120,735 2%

Corpbanca 4,902,129 97,379 2%De Crdito e Inversiones 9,206,394 195,127 2%

De Chile 13,480,840 180,899 1%

Deutsche Bank (Chile) 0 0

Falabella 604,470 17,153 3%

HSBC Bank (Chile) 276,218 0 0%

Internacional 317,466 4,602 1%

Ita Chile 2,318,064 36,999 2%

Monex 17,064 805 5%

Paris 203,066 11,159 5%

Penta 0 0

Rabobank Chile 197,062 2,258 1%

Ripley 227,354 15,661 7%Santander-Chile 14,465,485 392,959 3%

Scotiabank Sud Americano (1) 4,598,289 26,901 1%

Security 1,963,793 24,904 1%

The Royal Bank of Scotland (Chile) 244,509 101 0%

Banks of the Republic of Chile 9,348,966 466,883 5%

Foreign Banks Branches* 67,112 0 0%

De la Nacin Argentina 4,973 0 0%

DnB NOR Bank ASA 0 0

Do Brasil S.A. 21,272 0 0%

JP Morgan Chase Bank, N.A. 19,622 0 0%

Of Tokyo-Mitsubishi UFJ, Ltd. 21,245 0 0%

Sistema Bancario 69,646,254 1,793,769 3%

Del Desarrollo (5) 2,570,128 180,428 7%

*Representative offices only Source: Superintendencia de Bancos e Intituciones Financieras de Chile

ANNEX 2


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BOX 1 Fiscal Rule: Structural and Observed fiscal balances

Source: Columbia University, Prof. Sara Calvo, class material from Izquierdo, Ottonello and Talvi(forthcoming).

Chiles cyclically adjusted fiscal rule The rule was designed as a means of constraining the pressure to spend the high expected

revenues or to break the pro-cyclical behavior of fiscal policy (high copper prices, expandingeconomy).

The rule: the cyclically adjusted budget surplus to be no less than 1 percent of GDP. Theadjustment is with respect to the price of copper.

Chiles Cyclically-Adjusted Fiscal Balance = observed Fiscal Balance (term involving projections oflabor, investment and factor productivity to estimate potential output using a production function +projections of copper prices)

Centro Argentino de Estudios Internacionales WP 19

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