José De Gregorio: Monetary Policy Report
Presentation by Mr José De Gregorio, Governor of the Central Bank of Chile, before the
Honorable Senate of the Republic, Santiago, 8 September 2010.
* * *
Introduction
Mr. President of the Senate, senator Jorge Pizarro, ladies and gentlemen senators, I am
grateful for the invitation to the Board of the Central Bank of Chile to present our Monetary
Policy Report. Like every year in September, this presentation coincides with the yearly
report given by the Board of the Central Bank to the Senate, where we expose our vision of
recent macroeconomic and financial developments in the Chilean economy, as well as its
prospects and implications for the conduct of monetary policy.
In a few days we will be celebrating our country's bicentennial, in a year 2010 that has been
marked by tremendous human and economic challenges, and after a biennium 2008-2009
characterized by episodes of global recession and financial crisis that we had not seen in
decades.
The Chilean economy has been able to weather these difficulties in an unprecedented way.
Macroeconomic stability has been preserved and the negative effects on employment and
output of the turmoil of recent years have been properly dealt with. Thanks to that we are
now in a process of economic growth and recovery that is substantial, strong and healthy for
economic activity, demand and employment.
Indeed, despite the context of an increasingly uncertain global economy, Chile has continued
to show significant growth rates, has reduced unemployment and has advanced in repairing
the damages caused by the earthquake and tsunami that hit us last February 27th (27-F). At
the same time, after a prolonged period of very low and even below-zero figures, inflation
has returned to the defined tolerance range and is headed, according to our own projections
and private expectations, toward levels consistent with the 3% target range (figure 1).
That the stimulative monetary policy applied during all of 2009 bore fruit is without question.
The extraordinarily expansionary conditions implemented more than a year ago by way of a
historical reduction in the monetary policy interest rate, together with special liquidity facilities
and the communication that the monetary policy rate (MPR) would be kept at its minimum
level throughout the second quarter of this year, limited the persistence of the negative
effects of the crisis on the capacity of households, firms, and financial institutions to repay
their debts and generate income. Furthermore, these measures helped set the grounds for
the vigorous economic upturn we are seeing now.
The expansionary monetary stance of early this year permitted, also, to keep at bay the
financial effects of the earthquake and provide a lending environment that would foster
reconstruction. Toward the second quarter of this year, as confidence returned, with reliable
information that output and demand were picking up, together with prospects of inflation
returning to the target range, the Board began a gradual process of normalization of the
stance of monetary policy. Overall, at its current level the MPR is still expansionary, and will
continue to provide momentum to the economy (figure 2).
Since the last Report that we presented last June, incoming information point at the real
sector consolidating its renewed strength. Output and demand growth have exceeded
expectations, narrowing the output gap. In that context, as we have said before, the question
is not to continue or not to continue raising the MPR, but how fast to do it. As we know,
delaying this process can end up calling for drastic adjustments, higher interest rates and
increased pressures from the exchange rate, all of which is detrimental to employment and
economic activity.
As detailed in this Report, convergence of inflation to the target in the baseline scenario is
determined by stronger output and stronger domestic expenditure, but combined with
reduced pressures from abroad. In addition, in the short term we have seen some prices
increases, such as transport fares, cigarettes and the stamp tax. As for earlier projections,
these latter factors will contribute to somewhat less CPI inflation over the coming months.
The CPI figure published today is a little below the expectations of market agents and our
own, but as we have said time and again we do not react to the news of the day, although we
do take them into account to detect the trends. In any case this figure does not change the
direction of monetary policy. Nor does it modify our forecasts of strong growth with limited
inflation we include in this Report. Our monetary policy strategy is a preventive one, headed
to normalization, and does not respond - luckily - to an inflationary spurt or to some
unsustainable expansion process.
In this Report's baseline scenario, gradual progress toward MPR normalization is assumed,
but its level will continue to be expansionary still for several quarters. As always, the pace of
normalization will depend on how domestic and foreign macroeconomic conditions unfold,
and will be consistent with the inflation target.
Accordingly, it is essential that we do not lose sight of the external scenario. The latest
developments have increased uncertainty about the pace of global growth while financial
markets are still highly volatile. Also, the nominal appreciation of the peso over the past few
months has been substantial. Although the current levels of the real exchange rate do not
reflect an obvious misalignment with its long-term fundamentals, exchange rate movements
do affect the conduct of monetary policy significantly, as they play a stabilizing role. Indeed,
in mitigating inflationary pressures, an exchange rate appreciation restrains the MPR
adjustments that could result from only the closing of the output gap.
One working assumption we use in our projections is that the real exchange rate will change
little into the long term. Any movements away from its trend are possible in a floating regime.
Its potential financial effects on aggregate output and inflation will be definitely considered by
the Board as an input for its future decisions.
As we have demonstrated in the past, our monetary policy is highly flexible. It has
contributed enormously to the good standing the Chilean economy enjoys today, in an
environment of stable prices and restored employment and output. Now I will review the main
features of the macroeconomic conditions we believe are the most likely for the next two
years and its implications for inflation and monetary policy.
Macroeconomic scenario
The first closing of second-quarter National Accounts showed GDP growth at 6.5% y-o-y. In
terms of velocity, the second quarter ended with an annualized quarterly variation of around
20% (figure 3). Domestic demand also grew above forecasts, driven by increased private
consumption and a strong rebound of investment. Such dynamism has responded to not only
temporary factors but also to more persistent ones. Among the temporary factors, what
stands out is the immediate repair of the damages caused by the catastrophe of 27-F and
the reversal of the dramatic contraction of domestic demand during 2009, associated to the
then high levels of uncertainty. These elements resulted in a swelling of inventories, durable
goods purchases and investments in machinery & equipment.
Among the more persistent phenomena that are driving demand and output are the
stimulative effect of monetary policy, in an environment where the agents' balance sheets
suffered no permanent damages from either the crisis or 27-F.
Furthermore, different measures show that financial conditions have advanced toward
normalization in recent months, with a more favorable scenario in terms of both interest rates
and banks' lending standards. According to the banking credit survey of the second quarter,
credit access conditions were relaxed at the same time that a strengthening of demand was
observed. Loans have continued to grow, and interest rates are still low (figure 4). This
combines with the good performance of the labor market and expectations of consumers and
firms in the optimistic or near-neutral levels.
Reconstruction works in the aftermath of 27-F have affected domestic expenditures, albeit
with a different composition than was foreseen immediately after the disaster. At first,
everyone expected that public and private efforts would focus primarily on infrastructure and
construction, but capital goods imports and inventory replacement ended up being much
more significant. Still, the baseline scenario assumes that building investment will pick up
substantially towards the end of this year and in 2011, with some moderation of investment in
machinery & equipment, which is already visible.
Internationally, the weak incoming indicators for output and employment in the U.S. have
increased the concerns over a slower economic recovery of that country. World growth
forecasts are maintained for 2010, basically due to better than expected figures in the first
half, and because the latest data point at a weaker second half (figure 5). The breakdown
across regions has changed, with increased participation of emerging economies. In the
main developed countries, manufacturing production has decelerated. So far, consensus
forecasts do not fully consider this scenario, although financial asset prices have implicit
slower growth for the U.S. and foresee a delay in monetary policy normalization. Accordingly,
the Board assumes for the baseline scenario global growth again lower than market
consensus for 2010 and 2011 (table 1).
In international financial markets, risks associated to the fiscal and financial conditions in
Europe are less imminent, as reflected in banks' risk premiums and some liquidity indicators
in money markets. Uncertainty remains, however, relating with the risk of further weakening
of output in the developed world, causing a decline in long-term interest rates in the U.S., the
Eurozone, and Japan since June, to levels similar to or even below the troughs of late 2008
(figure 6).
Taking all these aspects in consideration, the Board estimates that during this year GDP will
grow between 5.0% and 5.5%. The range for this year has been upgraded from June, based
on actual data above projections in the first half and more dynamic figures available for
thirdquarter demand and output, which are foreseen to continue into the first half of 2011,
prompting output gaps to close in this latter period (figure 7).
For the year 2011 GDP is expected to grow by 5.5%-6.5%. Moderation of world growth
towards 2011, the dissipation of one-time effects of the crisis and 27-F, plus the gradual
withdrawal of monetary policy stimulus will result in both output and domestic demand
slowing down by the second half of 2011. It is worth noting that y-o-y GDP growth figures in
the second quarter of 2011 will be high due to the low basis for comparison associated to the
earthquake. Similarly, once the swelling of domestic demand is finished, it should expand
next year at a rate the half of the strong growth it should post this year. This will come
accompanied with more dynamic export volume growth that will revert the tough 2009 and
2010 years, when exports were affected by the global recession and by the disruptive effects
of the earthquake (table 2).
The rebound of the Chilean economy is also apparent in a dynamic labor market, where
employment is growing strongly and the rate of unemployment has dropped (figure 8). As for
fiscal policy, this Report's baseline scenario considers the announcements made by the
authority, which do not mention any significant changes in the fiscal stimulus for the coming
years from last June.
The behavior of output and demand will determine a current account deficit of -1.1% of GDP
this year increasing in 2011. At trend prices, these figures are large by historical standards,
reflecting the transitory effects of post 27-F on investment and saving, but should moderate
as these transitory effects dissipate.
In this Report's baseline scenario, despite the faster closing of the output gap, headline
inflation will follow a path similar to the one forecast before, but core inflation will be
somewhat more limited. This difference owes primarily to some specific prices and to the
incidence of reduced inflationary pressures from abroad (excluding foodstuffs).
Also, the inflation path is also influenced by the recent and forecast dynamics of the real
exchange rate (RER). The peso has appreciated in nominal terms by around 7% since our
last Report, partly responding to the performance of the dollar in world markets. In our
projections, we use as a working assumption that the RER will be unchanged in the long
term, which is consistent with its long-term fundamentals (figure 9). Reduced inflationary
pressures associated to the stronger peso certainly affect inflation prospects in this Report,
partly offsetting the effects on prices of the rapid closing of the output gap. As has happened
under different circumstances, any movements of the exchange rate away from the trend
assumed as a working assumption is possible in a floating regime, and its potential effects on
the financial system, output or employment will be considered by the Board as inputs for their
future decisions.
Summarizing, for the rest of this year, annual CPI inflation is expected to return to figures
around 3% to then move to the upper limit of the tolerance range for some months. This
short-term trajectory is influenced by one-time effects, which will eventually revert, permitting
inflation to hover around 3% throughout 2011 and to the end of the relevant projection
horizon, this time the third quarter of 2012. Y-o-y CPIX1 inflation will describe a more gradual
convergence to 3%, largely because the shorter-term effects on inflation are concentrated in
items outside the CPIX1. Private expectations are not very different from this (figure 10).
The Board estimates that it will continue withdrawing the monetary stimulus at a pace that
will depend on how domestic and external macroeconomic conditions unfold. This process of
MPR normalization was begun in June and continued in the meetings of July and August
- with increases of 50 basis points each time - taking the MPR to 2% y-o-y. Going forward,
the market has internalized a process of withdrawal of the monetary stimulus in the coming
quarters. This is consistent with the progressive normalization of credit conditions, which is
visible in various markets and indicators. The different surveys and asset prices can be read
in more than a way in regards the true pace of normalization.
Actually, the same as in June, the MPR implicit in swap contracts is lower than the one that
can be inferred from the forward curve, mainly reflecting significant differences between the
rates on non-indexed Central Bank bonds and swap contract as equivalent maturities. It is
possible that these differences originate in the type of institutions operating in each market,
which are not fully integrated, reflecting different preferences for instruments in pesos and in
UF by resident and non-resident institutions. Similarly, this partial integration may mean that
swap contract rates reflected more quickly and more intensely the movements of risk-free
interest rates abroad.
The baseline scenario of this Report uses as a working assumption an MPR trend that is
comparable to the one observed in various expectations surveys (figure 11). Certainly, if
actual conditions differ from those assumed in this baseline scenario, alternative policy
measures will be required.
Specifically, the Board believes that the scenario outlined here is subject to a number of
risks. Considering that in June domestic demand - and output - already was showing faster
than foreseen velocity, we cannot rule out gaps closing faster than assumed in the baseline
scenario. Nor can we rule out that some part of that strength responded to merely temporary
factors, such as the earthquake, and output will slow down before we think.
In the global context, several risks are still latent. U.S. growth may weaken more than
foreseen, with effects on financial markets - in particular stock index reversals - and new
postponements of the monetary stimulus withdrawal. The fiscal accounts in developed
economies - especially in some countries in Europe - is still cause for concern, mainly
because of their effects on perceived risks and in the final recovery of the world economy.
Furthermore, measures adopted in China to limit credit growth and prevent an overheating
may result in a weaker world economy and lower commodity prices. As usual, the
persistence of global imbalances entails risks both on capital flows across economic areas
and on the behavior of parities between different currencies.
In the recent past, the trajectory of international food prices has reopened the concern on its
future performance and its impact on inflation, given the high degree of pass-through we
observed in Chile from world price hikes in 2007 and the first half of 2008. Overall, it is not
that clear that, if wheat prices continue to rise internationally, the local economy will replicate
them, because domestic margins have remained fairly large.
If any of these scenarios materializes, there will be direct consequences for the growth and
inflation scenario foreseen by the Board. After considering all the elements described, the
Board believes that the balance of risks for inflation and output is unbiased, and we reiterate
that we will continue to use our policies with flexibility so that projected inflation stands at 3%
in the policy horizon.
Concluding remarks
Let me finish with some short reflections. After several years of heavy turbulences and
natural disasters, the Chilean economy is on a very good standing to continue on a path of
sustained growth.
Price stability has been preserved, preventing inflation from affecting the purchasing power
of citizens, especially those with less income and thus less capability to protect themselves
against this menace. Growth has consolidated, pushing the rate of job creation to levels we
had not seen in years. The contribution of monetary policy to this good performance is
unquestionable. It has been flexible enough to be able to be applied when facing sharp
changes in the economic environment, with no unnecessary dogma or rigidities.
In order for this process to continue over time it needs to be balanced and operate in the
context of an inflation rate in line with the target. Otherwise it will become just an
unsustainable acceleration calling for drastic adjustments with its related costs in lost output
and employment.
Evidently, as a country we continue to face challenges, particularly related to maintain
sustainable growth rates for long periods and not create tensions on price stability.
Guaranteeing low and stable inflation is the best contribution that the Central Bank of Chile
can make to prosperity in this new century of independent life that is beginning for our
Republic.
Thank you.
Figure 1
Inflation indicators EES: Inflation expectations
(annual change, percent) (percent)
12 12 7 7
6 6
9 9
5 5
6 6
4 4
3 3
3 3
0 0
2 2
1 1
-3 -3
02 04 06 08 10
06 07 08 09 10
At December 2010
IPC IPCX IPCX1
A diciembre del 2011
One year ahead
Two years ahead
Sources: Central Bank of Chile and National Statistics Institute.
Figure 2
Monetary policy interest rate
Real interest rate gap: Real MPR minus
(percent) indicated neutral interest rate
(percent)
10 10
6 6
8 8
3 3
6 6
0 0
4 4
-3 -3
2 2
0 0
-6 -6
07 08 09 10
00 02 04 06 08 10
Rate implicit in the CBC's forecasting
models
Rate resulting from consumption-based
model
Source: Central Bank of Chile.
Figure 3
IMACEC (1) Contribution to GDP growth
(index, 2003=100) (real annual change, percentage points)
25 25
135 135
20 20
15 15
130
130
10 10
5 5
125
125
0 0
-5 -5
120
120
-10 -10
115 -15 -15
115
07 III 08 III 09 III 10
07 08 09 10
GFCF
Inventory change
Government consumption
Private consumption
Net exports (2)
GDP
(1) Seasonally-adjusted series.
(2) Goods and services exports minus goods and services imports.
Source: Central Bank of Chile.
Figure 4
Loans by type of credit (1) Lending interest rates (3)
(annual change, percent) (percent)
30 30 50 50
20 20 40 40
10 10 30 30
0 0
20 20
-10 -10
10 10
-20 -20
0 0
98 00 02 04 06 08 10 02 04 06 08 10
Consumer, 181 days to one year (4)
Consumer Housing
Consumer, over three years (4)
Corporate (2)
Commercial, 30 to 89 days (4)
Commercial, 181 days to one year (4)
Housing, over three years (5)
(1) Provisional data for August 2010. (2) Sum of commercial and foreign trade credits. (3) Weighted averaged rates of all
operations performed in the month. (4) Non-indexed rates. (5) UF-indexed rates.
Sources: Central Bank of Chile and Superintendence of Banks and Financial Institutions.
Figure 5
GDP growh in selected regions and countries Monetary policy rates in the world (3)
(1) (2)
(annual change, percent)
(percent)
14
15 15 14
12
12
10 10
10 10
5 5
8 8
6
6
0 0
4
4
-5 -5
2
2
0 0
-10 -10
00 02 04 06 08 10 02 04 06 08 10
Developed economies (4)
América Latina Asia ex Japón
Emerging economies (5)
EE.UU. Zona Euro
Chile
Japón
(1) Regions are weighted by PPP as in WEO, April 2010. (2) Dots show growth forecasts for 2010 and 2011 respectively included in the
baseline scenario of September 2010's Report. (3) Solid lines describe simple-averaged reference rates of each group of countries. Dots
show averaged responses from analysts surveyed by Bloomberg during August 2010. These reflect expectations for September 2010,
December 2010, March 2011 and June 2011. (4) Includes Canada, the Eurozone, Japan, Norway, Sweden, Switzerland, the U.K. and the
U.S.. (5) Includes Brazil, Colombia, China, the Czech Republic, Hungary, Mexico, Peru, Poland, South Africa, South Korea and Turkey.
Source: Central Bank of Chile based on statistics institutes of each country, Bloomberg and IMF.
Table 1
Main international scenario assumptions
(yearly averages)
2009 2010 (f) 2011 (f) 2012 (f)
Jun.10 Sep.10 Jun.10 Sep.10 Sep.10
World GDP at PPP -0,6 4,3 4,3 4,0 3,8 4, 7
(annual change, %)
World GDP at market exchange rate -2,0 3,2 3,3 3,0 2,9 3,9
(annual change, %)
Trading partners' GDP -0,2 4,4 4,4 3,7 3,5 4,6
(annual change, %)
WTI oil price 62 77 77 80 79 82
(US$/barril)
LME copper price 234 300 320 270 290 290
(US$cent/libra)
Terms of trade 4,1 14,3 15,0 -7,2 -4,3 0,5
(annual change, %)
External prices, in US$ -6,2 3,4 4,6 3,3 2,3 4,7
(annual change, %)
(f) Forecast
Source: Central Bank of Chile.
Figure 6
Stock market volatility Long-term interest rates in
(percent) developed economies (3)
(percent)
6 6
120 120
5 5
100 100
4 4
80 80
3 3
60 60
2 2
40 40
1 1
20 20
0 0
0 0
05 06 07 08 09 10
07 08 09 10
Developed markets (1)
U.S. Japan Eurozone
Emerging markets (2)
(1) Uses VIX volatility index.
(2) Estimated volatility of the MSCI index in dollars.
(3) 10-year government bond interest rates.
Sources: Bloomberg and Morgan Stanley Capital International.
Figure 7
Output gaps (*)
(percent)
6 6
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
08 09 10 11
June 2010 Report September 2010 Report
(*) Gray area shows forecast as from the third quarter of 2010.
Source: Central Bank of Chile.
Table 2
Economic growth and inflation
(annual change, percent)
2008 2009 2010 (f) 2011 (f) 2012 (f)
GDP 3,7 -1,5 5.0-5.5 5.5-6.5
Domestic demand 7,6 -5,9 16,1 6,2
Domestic demand (w/o inventory change) 7,5 -2,8 11,3 7,4
Gross fixed capital formation 18,6 -15,3 21,2 13,6
Total consumption 4,0 1,8 8,3 5,3
Goods and services exports 3,1 -5,6 -0,3 6,1
Goods and services imports 12,2 -14,3 26,3 6,4
Current account (% of GDP) -1,5 2,6 -1,1 -2,5
Average CPI inflation 8,7 1,6 1,7 3,3
December CPI inflation 7,1 -1,4 3,9 3,2
CPI inflation in around 2 years (*) 3,0
Average CPIX inflation 8,4 2,8 0,8 3,6
December CPIX inflation 8,6 -1,8 3,5 3,5
CPIX inflation in around 2 years (*) 3,1
Average CPIX1 inflation 7,8 2,8 -0,3 3,0
December CPIX1 inflation 7,7 -1,1 1,5 3,2
CPIX1 inflation in around 2 years (*) 3,0
(f) Forecast.
(*) Inflation forecast to the third quarter of 2012.
Source: Central Bank of Chile.
Figure Figure 8 8
National National Figure 9 employment employment and and unemployment unemployment rate rate
(percent; (percent; millions millions of of persons) persons)
Real exchange rate (*)
(index, 1986=100)
Universidad Universidad de de Chile Chile (*) (*) INE INE
120 120
14 14 2,8 2,8
12 12 7,5 7,5
110 110
12 12 2,6 2,6
11 11 7,0 7,0
100 100
10 10 2,4 2,4
10 10 6,5 6,5
90 90
8 8 2,2 2,2 9 9 6,0 6,0
80 80
8 8 5,5 5,5
6 6 2,0 2,0
70 70
7 7 5,0 5,0
4 4 1,8 1,8
88 90 92 94 96 98 00 02 04 06 08 10
Mar.09 Mar.09 Ago.09 Ago.09 Ene.10 Ene.10 Jun.10 Jun.10
03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10
RER Average 1990-1999 Average 1995-2009
Unemployment Unemployment rate rate
Unemployment Unemployment rate rate
(*) The dot shows the real exchange rate as of 6 September 2010.
Employment Employment
Employment Employment
Source: Central Bank of Chile.
(*) (*) Seasonally-adjusted Seasonally-adjusted series. series.
Figure 9
Real exchange rate (*)
(index, 1986=100)
120 120
110 110
100 100
90 90
80 80
70 70
88 90 92 94 96 98 00 02 04 06 08 10
RER Average 1990-1999 Average 1995-2009
(*) The dot shows the real exchange rate as of 6 September 2010.
Source: Central Bank of Chile.
Figure 10
CPI inflation (1) Incidences on annual CPI inflation (1)(2)
(annual change, percent) (percentage points)
10 10
10 10
8 8
8 8
6 6
6 6
4 4
4 4
2 2
2 2
0 0
0 0
-2 -2
-2 -2
-4 -4
-4 -4
06 08 10 12
03 04 05 06 07 08 09 4 4
IPoM jun. 2010
Public utilities (5,43%)
IPoM sep. 2010
Fuels (5.7%)
Foodstuffs w/o fresh fruits and vegetables (21.32%)
Fresh fruits and vegetables (2.90%)
Other (64,65%)
(1) Gray area shows forecasts as from the third quarter of 2010.
(2) In parentheses, shares in the CPI basket with annual base 2009. For the period 2003-2008, weights in the basket of December 1998.
For 2009, weights in the basket of December 2008.
Sources: Central Bank of Chile and National Statistics Institute.
Figure 11
Actual and expected MPR
(percent)
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
07 08 09 10 11 12
Forward, June 2010 Report Forward, September 2010 Report
FOS 2Q August 2010 EES August 2010
MPR
Source: Central Bank of Chile.