MONETARY POLICY REPORT
BEFORE THE OF THE
PRESENTATION FINANCE COMMISSION
OF THE
HONORABLE SENATE REPUBLIC
Mario Marcel
Governor
Central Bank of Chile
9 June 2021

The June 2021 Monetary Policy Report can be found at http://www.bcentral.cl.
I. Introduction
Madam President of the Finance Commission of the Senate, senator Ximena Rincón, Senators members of this
Commission, ladies, gentlemen,
I am grateful for your invitation to present the view of the Board of the Central Bank of Chile (CBC) on recent
macroeconomic developments, their outlook, and implications for monetary policy. This view is contained in detail
in the June 2021 Monetary Policy Report published this morning. This background provides the context for the
decision adopted by the Board at yesterday's Monetary Policy Meeting.
The last few months have confirmed that the Chilean economy has been making progress in its recovery process.
Activity figures brought positive surprises in the first months of 2021, reflecting the strong macroeconomic
momentum and the better adaptation of the economy to the sanitary restrictions. In fact, the impact of the
quarantines, despite involving almost 90 percent of the national population during April, was considerably milder
than we expected and also less compared with figures early into the pandemic.
Private consumption has risen strongly, fueled by the massive fiscal transfers that have been implemented in
recent months and the pension savings withdrawals. In fact, private consumption is the fastest growing
component of spending, with some of its categories, such as durable consumption, increasing at rates of 50
percent annually in the first quarter. The measures recently approved by Congress will intensify the boost to
consumption, while fiscal expansion will be significantly higher than we expected in the March Report.
In the projections I will be sharing with you in a few moments, we see a significant upward correction in growth
for this year, to between 8.5 and 9.5 percent. This responds to the better performance recently combined with
increased boost to expenditure, in the context of more favorable external conditions. In addition, this brings
forward the expected closing of the wide activity gap caused by the Covid-19 crisis.
Despite these advances and more positive prospects for recovery, the overall perception remains marked by the
evolution of infections and quarantines, the significant lags in some sectors, labor market fragilities and
persistently high uncertainty. In the financial market, long rates have risen more than their external counterparts,
the stock market has fallen, and sovereign risk has shown moderate increases.
Looking ahead, greater fiscal expansion and highly dynamic consumption will take pressure off the monetary
impulse to support the recovery of the economy, so it should begin to moderate earlier than expected in the last
Report. This will prevent an increase in inflation-currently at around 3.5 percent-from raising the cost of living
and eroding the purchasing power of the households most affected by the crisis. Even so, it is estimated that, in
the central scenario, the Monetary Policy Rate (MPR) will stay below its neutral level throughout the policy
horizon, underpinning a recovery process that will continue to be met with significant challenges.
I will now describe our assessment of the economic outlook and related risks.
II. The macroeconomic scenario
So far into this year, the Chilean economy has outperformed expectations, notably because the impact of the
quarantines on activity was significantly milder than we anticipated. In fact, although activity declined during
March and April, the effect of the increased sanitary restrictions was about one fifth of what we saw at the onset
of the pandemic. Several factors have contributed to this result: the greater adaptation of businesses to the social
distancing requirements; the support of favorable financial conditions; adjustments to the Step-by-Step Plan; and
the boost to demand by public policies (Figure 1).
Pension fund withdrawals and massive fiscal transfers have been fundamental determinants of the dynamism
of private consumption, which has spearheaded the economic upswing. In the first quarter, private consumption
had already grown by almost 5 percent annually, with a nearly 50 percent increase in spending on durables, most
notably to purchase technological items and automobiles. Information from retail trade, supermarket sales, and
electronic billing shows that consumption of goods remained dynamic through April and May. Spending on
services, despite recovering part of last year's decline, continues to show negative annual variation rates,
reflecting the persistence of supply-side constraints.
In the first quarter, Gross Fixed Capital Formation (GFCF) posted slight annual growth, driven by the recovery
of its Machinery & Equipment component, which grew 21.5 percent annually. The Construction & Works item,
on the other hand, fell by 10 percent year-on-year, due to works being slowed down and/or postponed because
of the pandemic (Figure 2).
The labor market has shown a noticeable, albeit heterogeneous, improvement with respect to its worst levels
of last year. The measured magnitude of this improvement varies depending on the source of information: while
National Statistics Institute (INE) data show the recovery of more than half of the jobs lost since the beginning of
the pandemic, the number of pension fund and unemployment insurance contributors -which can be associated
with formal salaried employment- has returned to pre-pandemic levels (Figure 3). At the same time, inactivity
has declined, although it remains high by historical standards, and vacancies have increased, with the result that
the unemployment rate remains at around 10 percent.
In any case, there are different indicators showing the fragility and heterogeneity of the labor market's
recovery, even though it still has a long way to go. On the one hand, the recent extension of quarantines had a
greater impact on self-employment and informal salaried work, and there was also an increase in unemployment
insurance applications, although still below their 2020 levels. Low-skilled workers and women continue to be the
segments that lagged the most in the recovery of employment (Figure 4). In fact, the female participation rate is
still far from its pre-pandemic levels, affected by the extra responsibilities on home care that many women have
had to assume. This issue is examined in one of the boxes of this Report, and I will refer to it in more detail in a
while (Figure 5).
Since the previous Report, benefits for households and small businesses have been expanded and will be
significantly increased with the measures recently approved by Congress within the framework of the "Common
Minimums Agenda". In the second half of April, the Government announced the strengthening of the
middleclass bonus and the Emergency Family Income, together with a complementary bonus for those with empty
pension fund accounts. Congress also approved a third withdrawal of pension savings, which includes an advance
of benefits for pensioners with annuities. In the context of the Common Minimums Agenda, a substantial
extension and expansion of transfers has just been approved, including an Emergency Family Income, which will
be extended in amount and coverage, and will reach more than 15 million people over the next four months. In
addition, the provision of subsidies and tax benefits for micro and small businesses is being discussed.
These initiatives combined will push fiscal spending growth to around 25 percent in nominal terms in 2021,
which compares to the 5 percent considered in the March Report. This will lead to a significant overshoot of the
structural deficit planned for the year, which the government would formalize by invoking an "exit clause" from
the committed fiscal targets. Although new official projections are not yet available, it seems clear that, despite
the improved outlook for activity, this year's fiscal impulse will not only exceed the forecast but will be significantly
higher than in 2020.
Despite the recovery of activity and the extension of fiscal packages, the overall economic sentiment worsened
in recent months, with consumer expectations still in pessimistic ground. This could be explained by factors such
as the evolution of infections and quarantines, and the heterogeneity observed in the recovery. About the latter,
it stands out that the performance of part of services, construction and passenger transportation sectors is still
not matching pre-pandemic levels, a milestone that trade and manufacturing achieved six months ago or before.
Add to this the aforementioned heterogeneity in the labor market (Figure 6).
Differences are observed in the case of business expectations, with smaller firms and hardest-hit sectors lagging
behind in the recovery. The Business Perceptions Report (IPN) for May reported that smaller companies were the
worst affected by the quarantines in March and April. In addition, the IPN noted that a significant percentage of
companies were having second thoughts about their investment plans for this year or had simply decided to shelve
them altogether.
Uncertainty indicators remain high and well above those prior to the social crisis. Actually, in the last year, local
uncertainty indicators have consistently outweighed those of economies such as the United States or the United
Kingdom, as the decline to their pre-pandemic levels has taken longer. This trajectory clearly differs from what
used to be the case before the social outbreak, when the level of uncertainty was not only much lower, but also
more in line with other countries (Figure 7).
The Chilean financial market has reacted to the overall local developments by decoupling itself from global
trends. Thus, long-term interest rates have increased by 30 basis points since mid-April to date (BCP10), while
their external benchmarks have not changed much. This has been accompanied by a stock market drop of just
over 10 percent, a 2 percent depreciation of the Peso and an increase in the sovereign premium (CDS) of 15 basis
points, all despite the significant rise in the copper price. This has coincided with a period of heightened political
tensions surrounding the third pension savings withdrawal and a wide range of legislative initiatives on fiscal and
regulatory matters (Figure 8).
On the external front, world growth has been consolidating the positive outlook for this year and next, which
has been internalized by the global financial markets. The evolution of the external scenario is closely linked to
the progress of vaccinations and business reopening in developed countries, which has resulted in a rebound and
strengthening of consumer and business confidence and activity in the lagging sectors (Figure 9). Regarding the
composition of spending, while the recovery of activity in the main economies was initially driven by consumption,
between the end of 2020 and early 2021, investment showed a more dynamic behavior (Figure 10).
Global financial markets have captured this outlook, encouraging greater risk-taking, stock market rises and
widespread asset price appreciations. As a result, financial conditions have remained favorable, particularly due
to the greater stability of long-term rates, the decline in corporate spreads and risk premiums, and capital inflows
to emerging markets. However, this picture is not common to all economies, with significant lags in those where
pandemic control remains complex, where there is no significant vaccination plan in the short term, where policy
space is limited, and/or where domestic tensions have increased. This is the case in several Latin American
countries.
International commodity and food prices have also been boosted by the global recovery, in the presence of
supply-side difficulties and a depreciated dollar. Copper hit a record price of USD 4.86 per pound early in May
and is close to USD 4.5 as of the statistical close of this Report, which is 11 percent higher than its March price.
The oil price has also risen and is now above USD 65 per barrel.
This, along with higher transportation prices, has increased the cost pressures faced by companies around the
world. In fact, the cost of maritime freight has tripled, and the prices of other inputs and commodities, such as
construction materials, food and agricultural produce, have also risen considerably (Figure 11). All of this has been
reflected in higher producer prices and increased short-term inflation expectations in several economies.
Although global markets expect the effect on inflation to be mostly temporary, concern has increased in those
economies where demand-boosting policies have been most significant. In the United States, inflation surprised
to the upside in March and April, while a large fiscal stimulus package is being implemented and monetary policy
remains highly expansionary. Measured inflation expectations have risen, while financial markets have
experienced bouts of inflation-related volatility.
In Chile, inflation has evolved as expected, as the CPI's annual change rose to 3.6 percent in May. Expectations
are in line with the two-year policy target. The annual variation of the CPI has continued to be mainly determined
by the behavior of goods and energy prices. The former continues to be pressured by tight inventories in a context
of high demand. The latter reflects the rise in oil prices and the low comparison base. Core CPI today stands at 3.4
percent (Figure 12).
III. Projections
Expected growth for this year substantially increases in the central scenario, to a range between 8.5 and 9.5
percent. About two-thirds of the difference with the March forecast is explained by the buildup of
expenditureboosting measures, and the other third mainly by the better start of the year and the adaptation of the economy
(Figure 13). It is important to note that, assuming that after the March and April setbacks, the economy returns
to February's level and stays there for the rest of the year, GDP growth in 2021 would be close to 7.5 percent even
before considering any effects from the third pension-fund withdrawal and the massive fiscal transfers (Figure
14).
The vast fiscal transfers and the approval of the third withdrawal of pension savings result in projecting annual
private consumption growth at around 15 percent (around 12 percent in March). Meanwhile, GFCF is forecast
to rise by 11.4 percent in the year, and total exports to do so by 1 percent.
For 2022 and 2023, expected growth ranges are revised downward, given the higher base of comparison, the
gradual decline in the consumption impulse and limited investment dynamism. In the central scenario, GDP will
increase between 2 and 3 percent in 2022, and between 1.75 and 2.75 percent in 2023. The annual increase in
private consumption will moderate significantly over the next two years, largely reflecting the transitory nature
of the current income-support measures (Table 1).
For investment, significantly lower expansion rates are expected for 2022-2023 than for 2021. Beyond the higher
first-quarter effective result and the cyclical recovery expected for this year, the outlook points to limited
dynamism. On the one hand, the latest available version of the CBC's survey of large-scale investment projects
shows little change in the number and volume of projects committed for the next five years and a low inflow of
new projects by historical standards, a trend that has been maintained for some quarters now. On the other hand,
although imports of capital goods increased significantly in the first part of the year, the evolution of the stock
market suggests a less optimistic outlook for the tradable component of investment going forward (Figure 15).
A core element in these projections is fiscal policy, which this year will add a significantly stronger impulse than
we contemplated in March, considering the announcements already materialized and the additional spending
that will trigger, among other measures, the recently approved household support initiatives. For 2022 and
2023, it is assumed that a massive fiscal impulse such as this one will not be maintained, giving way to policies
focused on the most lagging segments and the stabilization of public finances. Thus, after reaching record
expansiveness in 2021, the central scenario assumes that fiscal accounts will enter a path of convergence to
structural targets and towards a sustainable public debt-to-GDP ratio, in line with the recommendations of the
Autonomous Fiscal Council. This could be reinforced through permanent increases in tax revenues stemming from
the reforms that have been recently announced by the Government.
This year's Current Account deficit will match the March forecast, because the higher copper price compensates
for the expansion of domestic expenditure. All in all, between 2020 and 2021, the Current Account balance will
turn negative, reflecting the increase in domestic demand. Compared to March, during the three-year period
2021-2023, the world economy will see slightly higher growth rates and the average annual copper price will be
20 to 30 cents above the downsloping trend projected in March. In addition to the recent rise, this correction
responds to the higher long-term copper price, which is increased to USD 3.3 per pound, from USD 2.7 previously.
Despite the oil price hike over the projection horizon, the terms of trade are, on average, 4 percent higher than
we estimated in March (Table 2).
The better actual and expected performance of GDP this year leads to an earlier closing of the output gap than
anticipated in the March central scenario. This considers that the strong growth in domestic demand, associated
with consumption, will boost effective GDP in the short term. Because of this, and despite the second-quarter
pullback and the upward correction to potential GDP (which I will touch upon in a few moments), the gap will
close during the third quarter of this year, turning positive for a few quarters. It will then fall in 2022 in line with
the reduction of stimulus to private spending, oscillating around zero until the end of 2023 (Figure 16).
The stronger boost to consumption, in a context of earlier closing of the output gap and increased cost
pressures, adjusts our inflation projection up. Core inflation will close the year slightly below 4 percent annually.
Higher energy prices will continue to dominate the volatile component. Thus, after rising in the second half of the
year, total annual CPI inflation at December 2021 will be 4.4 percent. In 2022 and 2023, as fiscal and monetary
impulses normalize, inflation will converge to 3 percent and remain there until the end of the policy horizon, that
is, the second quarter of 2023 (Figure 17).
To sum up, the higher activity forecast for this year is largely explained by the increase in private consumption,
responding to the many stimulus measures adopted after the last Report. A significant number of these
measures reflect that the fiscal policy is considerably more expansionary than previously expected. The outlook
for investment and exports, on the other hand, is more limited, with a tendency to decelerate in the former. Thus,
a recovery scenario notoriously biased towards consumption is emerging, which, if maintained or deepened with
more procyclical policies, could incubate larger macroeconomic imbalances, a risk that should be duly monitored.
IV. Re-estimating the structural parameters of the Chilean economy
The structural parameters correspond to longer-term estimates of different economic variables: namely GDP
growth, the neutral MPR, and the prices of selected commodities, which provide context to long-term
projections and monetary policy formulation. These are the so-called "unobservable variables", meaning that
they cannot be measured directly (as can activity in a month or a year, for example) and thus must be estimated
using different methodologies. The estimation of structural parameters is relevant for monetary policy decisions,
as it provides a reference of where their values should stand over longer terms and therefore serves as a guide
for assessing the macroeconomy and calibrating monetary policy accordingly. In 2020, the Bank postponed the
review of these parameters because the uncertainty surrounding the unusual nature of the shocks that were
affecting the economy -the social crisis and the pandemic- made it more advisable to gather more information
to assess the medium-term effects on the economy. The results of these estimates are detailed in three boxes of
this Report.
As for trend growth, its estimate is revised downward given the persistent slowdown in productivity growth
over the last decade. Our estimate for non-mining trend GDP growth is reduced to a range between 2.4 and 3.4
percent for the 2021-2030 period, which compares to the range between 3.25 and 3.75 percent estimated for the
2019-2028 decade. This revision is mainly explained by a lower Total Factor Productivity (TFP) growth projection.1
This assumption is based on the consolidation of a downward trend since the early 1990s, which was only
temporarily reversed during the commodity price boom of the second half of the 2000s (Figure 18). In any case,
it is important to note that this assumption is subject to a high degree of uncertainty, which is reflected in a wider
range of trend growth estimates, that goes from half a percentage point to one percentage point between the
2019 estimate and the current one. This partly reflects the fact that these estimates do not include the potential
effects in either direction of the structural changes induced by the pandemic or by the political-institutional
process underway.
Potential GDP -which measures growth capacity over shorter terms, where full resource allocation is not
achieved- is revised upward, despite the downward correction to trend growth. For the 2021-2023 period,
potential growth is estimated at around 2.1 percent (around 1.7 percent in March). This reflects the greater
adaptive capacity of the economy and the smaller scars that the pandemic would be leaving, which reduces the
persistence of its negative effects on productivity and factor availability. All in all, in the medium term, potential
GDP should converge to figures comparable to trend GDP.
For the neutral MPR, the sum of estimates yields figures of the order of 0.5 percent in real terms. Consistent
with the range of estimates and the uncertainty surrounding this calculation, the Board considers that the neutral
MPR lies in a range between 3.25 and 3.75 percent in nominal terms, a 50 basis point decline in the bounds of the
range estimated until March. This partly reflects the global trend towards lower neutral interest rates observed in
recent years and is consistent with the reduction in the trend growth estimate for Chile.
The technical minimum of the MPR is kept at 0.5 percent. As in March 2020, this considered that the money
market is managed by various administrators competing with each other and with banks. Among others, they
offer quick exit investment instruments that allow them to meet the immediate cash needs of households and
businesses, being able to withdraw their funds the following day. When selling these instruments, there may be
price differences that need to be covered. Therefore, as the MPR approaches zero, the probability that firms and
households will incur losses increases. To keep this mechanism in operation, the Board estimates that the
technical minimum of the MPR is 0.5 percent. Still, it is important to note that this technical minimum is not a
constraint for an expansionary monetary policy, thanks to the fact that we are far from a deflationary scenario.
Moreover, the interbank rate can move within a corridor of ±25 basis points around the MPR and, in fact, in
periods of high monetary expansion, it has been below the technical minimum. This has been the case in the last
year and was also the case in 2009, when the MPR also hit 0.5 percent and the Bank used its Term Liquidity Facility
(FLAP).
1
It should be noted that the present exercise has used TFP information from the last four years. The previous trend growth
update (2019), only considered changes in the labor factor associated with immigration to the country, without modifying
the TFP growth assumption made in the previous estimate (2017).
As for the long-term prices of copper and oil, they are revised in opposite directions. Copper is raised from USD
2.7 to 3.3 per pound, while oil is reduced from USD 70 to 60 per barrel. It should be noted that these prices are
the ones where the prices of copper and oil are expected to be in 10 years' time. In the case of copper, this is
different from the assumption used in the calculation of the structural rule, which corresponds to the average of
the next ten years, and not its end point.
The upward revision to the copper price stems from the expectation of exponential growth in copper demand
associated with the "green wave". This presents itself in a context where, although conventional demand is
declining, the foreseen increase in production will be insufficient to offset the aforesaid demand increase due to
said "green wave" towards 2030. For this to occur, new investment projects would need to enter the sector, and
there are no such projects in sight. Moreover, in the past year different international organizations and specialized
institutions have raised the copper price expectation five and ten years ahead and is now around USD 3.3.
In the case of oil, long-term price estimates have fallen in recent years, pulled by both the arrival of new drilling
and production technologies and the projected fall in demand. In this market, the entry of shale oil brought down
average global oil extraction costs. In addition, the "green wave" would discourage the demand for oil compared
to projections of a few years ago. However, it is expected that a price of around USD 60 per barrel will be sufficient
to balance out the market in the long term (Table 3).
V. Sensitivity and risk scenarios
The central scenario is built using a set of assumptions, as I have just described, which shape the projections.
Sensitivity tests can be performed on said assumptions that, while keeping GDP growth in the foreseen ranges,
require a somewhat different monetary policy action. These scenarios form the MPR Corridor (Figure 19).
On the one hand, it is possible that demand will expand more than expected, either due to a greater willingness
of households to consume-in a context of a gradually deconfined economy-or due to fiscal transfers
exceeding those already considered. In the latter case, tax, liquidity or public investment measures could be
added, prompting an even more procyclical fiscal policy behavior. In such a situation, higher inflationary pressures
would lead to the need for an earlier withdrawal of the monetary stimulus, which is reflected in the upper bound
of the MPR Corridor.
On the other hand, investment continues to be the most lagging component of expenditure, and a less favorable
than expected evolution cannot be ruled out. The data show that in the first quarter investment in construction
and works failed to recover, that no major investment projects have entered the surveys and that domestic
political/legislative events have affected the stock market, which is typically correlated with the future evolution
of investment. If this situation were to worsen to stagnant or declining investment, monetary policy would have
to remain highly expansionary for a longer period, which is reflected in the lower limit of the MPR Corridor.
Although the economy has shown significant recovery, the pandemic phenomenon is still present and
unexpected events may occur. The central scenario considers that during the second half of this year, there will
be growing de-confinement of the population and the social distancing measures will be relaxed, as the goals of
the vaccination campaign are achieved. However, scenarios of a slower opening are possible. As a matter of fact,
infections have increased again, and quarantines have been re-imposed in several districts. If this intensifies, the
closing of the activity gap could be delayed, requiring the current monetary expansionary stance to be maintained
for a while longer.
On the external front, it cannot be ruled out that the cost pressures faced by companies around the world will
have more persistent effects on inflation. The global recovery, in a context of ongoing logistical problems for
production, has led to a widespread increase in costs. For now, this is expected to be a transitory phenomenon,
as the increasing openness of economies and greater adaptation will normalize the supply of many goods and
services. In any case, considering also the high domestic demand, local inflation may be somewhat higher than
expected in the short term. The temporary nature of such an event does not require a monetary policy reaction.
However, the scenario would be different if these global inflationary pressures were to have a more persistent
impact on local inflation. In that case, an earlier withdrawal of the monetary stimulus would be necessary.
In addition to the sensitivity tests, risk scenarios are analyzed in which the changes in the economy would be
more significant and which would call for a more intense monetary policy reaction. At home, the risks associated
with an evolution of public finances that is not clear about their long-term stabilization stand out, which could
affect domestic financial conditions, investment, and the perception of country risk. Externally, the main risk
continues to be an abrupt change in international financial conditions, an event that has become more prevalent
due to doubts about the evolution of inflation in the United States. The intensity of these scenarios may jeopardize
the convergence of inflation within the policy horizon, push activity below the expected ranges, and/or
compromise the proper functioning of financial markets.
VI. Monetary policy orientation
The recent improvement in the economy's performance, the significant boost to domestic demand, the
imbalances in the dynamics of spending and production, together with cost pressures, will influence the
behavior of prices. How much will correspond to temporary effects and how much to more persistent ones will
be key to determine the correct degree of expansion of the monetary policy stance, in order to ensure that the
recovery of the economy is sustainable and continues to unfold in an environment of stable prices.
In the immediate future, the Board estimates that the economy is still suffering from the impact of the
pandemic and the lag of the labor market in the recovery. However, the high dynamism that consumption already
exhibits and the additional boost to private spending represent major changes in the macroeconomic scenario of
the coming months, making it necessary to recalibrate the expansionary nature of monetary policy going forward.
In particular, the expected higher growth in spending and activity will make it less necessary for the monetary
impulse to support the economy's recovery with the current intensity, and it should begin to gradually
moderate sooner than we anticipated in the last Report. This will help to avoid the buildup of inflationary
pressures at a particularly sensitive time of the recovery. It is important to bear in mind that inflation is particularly
detrimental to middle- and low-income households, which do not have the purchasing power and asset protection
mechanisms available to the better-off. Therefore, a scenario of higher inflation would only reinforce the
regressive impact of the job losses that these sectors have suffered during the crisis.
In any case, even in a context of gradual normalization, monetary policy will continue to accompany the
recovery of the economy. Thus, starting from one of the most expansionary levels among comparable economies
(Figure 20), the central scenario anticipates that the MPR will remain below its neutral value throughout the
twoyear policy horizon. This will provide room for other public policies to support the sectors that are lagging behind
or need to adjust to the new operating conditions.
As for unconventional measures, they were recently concluded, and no changes are foreseen in their current
conditions or terms. This involves completing the phase of reinvesting bank bond coupons at maturity, permitting
the stock in the hands of the