Rodrigo Vergara: Chile's latest Monetary Policy Report
Presentation by Mr Rodrigo Vergara, Governor of the Central Bank of Chile, of the Monetary
Policy Report before the Finance Commission of the Honorable Senate of the Republic,
Santiago de Chile, 3 April 2012.
The Monetary Policy Report of March 2012 can be found at http://www.bcentral.cl.
* * *
Introduction
Mr. President of the Senate's Finance Commission, Senator José García Ruminot, senators
members of this Commission, ladies, gentlemen. I am grateful for your invitation to present
the vision of the Board of the Central Bank of Chile on recent macroeconomic developments,
their prospects and implications for monetary policy making, which is contained in detail in
our March 2012 Monetary Policy Report.
When we presented our previous Report to this Commission last December, the international
financial markets - and, though to a lesser extent, the Chilean market
too - were going through significant tension. The outlook for growth in Chile and in the world
at large reflected great uncertainty, and there was significant risk of the situation in the
Eurozone aggravating and becoming the Lehman Brothers' downfall of September 2008
revisited. We then were emphatic in saying that the Chilean economy was healthy, but that
the crisis abroad could end up affecting our growth prospects. We also said that the
magnitude of those effects was difficult to estimate. In that context, we lowered the growth
range forecast for 2012 and pointed out that, given the international threats facing us, the
balance of risks for growth was biased downward. We stated our willingness to take action in
order to mitigate the impact of the external scenario on the Chilean economy, having the
necessary tools to deal with adverse situations.
Thus, in late December we took exceptional measures to ease the frictions present in the
domestic money market and, in January, we preemptively reduced the monetary policy rate
(MPR) by 25 basis points. Facing the uncertain external situation, the expectations of most
market analysts and brokers anticipated the need for further reductions of the MPR.
With the passing of time, we have seen a somewhat more favorable evolution of the external
scenario. In general, confidence has partially returned to global financial markets, expressed
in lower risk spreads and higher commodity prices. The outlook for world growth is still weak,
even lower than our expectations in December, but the likelihood of a more adverse scenario
has decreased.
In Chile, domestic demand and output have outperformed December's projections.
Meanwhile, inflation has also exceeded projections and core inflation measures have
normalized rapidly. All this has modified the balance of risks for the Chilean economy from
December to date. Some months ago, the biggest risk was that a deteriorated external
scenario could trigger a sharper deceleration of domestic demand and output and, thus, of
inflation too. Today, the medium-term growth and inflation risks are unbiased, although in the
short-term there are greater inflation-related risks.
Our monetary policy is based on an inflation target two years ahead, so it requires having an
opinion with respect to the most likely evolution of the macroeconomic scenario and
associated risks. We are continually on the lookout for news about the local and international
economic environments, checking them for consistency with our vision of the most likely or
other alternative scenarios. To do so, we need to permanently adapt our vision on the
economy and conduct monetary policy with flexibility, being careful not to overreact to
onetime news that could trigger excessive pessimism or optimism that occasionally affect the
expectations of consumers, businesses or investors in the financial markets. This prudence
in our assessment of the state of the economy and related risks is vital for us to properly
meet our obligations. At the same time, it is our job to provide grounds for our vision about
the macroeconomic scenario and its consequences on the orientation of our monetary policy.
The developments of recent months exemplify this. Many market agents' opinions pointed at
the Chilean economy being severely hit by the external situation. However, incoming data
have shown us, as I said, that the risks coming from abroad are smaller than we thought
before. Also that the domestic economy has continued to grow strongly, which is reflected in
our GDP growth range for this year that we have revised upward from December.
The tensions we saw at the end of last year in external financial markets have eased, thanks
to a combination of facts. On one hand, the provision of three-year loans by the European
Central Bank helped to alleviate banks' liquidity and sovereign debt problems. On the other
hand, the second rescue package for Greece and the debt swap with the private sector
warded off the possibility of a disorderly outcome there. And somewhat better output and
employment indicators for the U.S. have been disclosed. Thus, the markets' volatility
decreased, risk and liquidity spreads fell, the dollar depreciated in international markets,
while asset prices rose, and so did commodity prices.
All considered, the risks in the external scenario, although more limited, are still significant.
The economies of peripheral Europe need substantial funding this year and next. The
governments must implement large fiscal adjustments, which in practice may encounter
increasing political and social resistance, the same as the financing of new rescue packages
in the surplus economies in the region. The economic, social and political costs are paid in
the short term and may create tensions, while its fruits can only be reaped in the medium
term. Furthermore, the banking system is facing capitalization challenges that may curtail
credit to the private sector. Rigidities of exchange rates and wages delay the resolution of
competitiveness problems in some economies. All this, aside from shaping a very frail growth
scenario in the zone, opens the door to new stress episodes in external financial markets.
Although so far the international scenario has not been as negative as was expected, taking
for granted that the slower global growth and tensions in external financial markets will not
affect our economy is not wise thinking.
Thus, while the inflation trajectory in Chile, the stronger growth in demand and output and
changes in certain prices such as oil and fresh fruits & vegetables, have risen the risks for
short-term inflation, the risks in the external scenario are still significant.
Let me now describe the macroeconomic scenario assumed in our Monetary Policy Report.
Macroeconomic scenario
Relative to December, world growth shows no major change on aggregate, although its
composition has changed and, certainly, so have the associated risks. In the United States,
improved figures of job creation, manufacturing output and expectations reflect on upward
revisions to forecasts for this year, partly offsetting the gloomier outlook for the Eurozone. A
somewhat deeper recession is expected in the zone for this year, which, due to its
commercial and financial links, reflects, albeit marginally, in revised growth projections
elsewhere, especially in emerging Europe and Asia. With respect to December forecasts,
trading partners' growth is unchanged for 2012 and 2013.
The baseline scenario also assumes that the oil price will remain high for longer than
projected in December. It also raises projections for the copper price to averages of US$3.7
and US$3.6 per pound this year and next. This translates into better terms of trade than
previously thought (table 1). Greater appetite for risk has also fostered a resumption of
capital inflows to emerging economies. Facing reduced tensions, many emerging economies'
central banks have suspended their processes of enhanced monetary stimulus they began in
the second half of 2011.
In Chile, the external financial turbulence has had limited impact, and a number of the signs
of spill-over that were perceived in late 2011 have reverted, at least partially. Money market
frictions have eased. Stock markets and the exchange rate have returned to values from
before the resurgence of international financial tensions, although corporate risk premiums
are now higher than they were in mid-2011. At the statistical cutoff date of this Report, the
peso had appreciated nearly 6% against the dollar, since the closing of December's Report.
Considering the current level of the nominal exchange rate and the parities prevailing at the
closure of this Report, the real exchange rate (RER) is estimated to be within the range
consistent with its long-term fundamentals.
On the other hand, domestic output and demand have grown faster than forecast in
December. After losing strength in the third quarter of 2011 - which was the information at
hand at the closing of the December Report - output figures of the fourth quarter
accelerated. Domestic demand has posted high y-o-y growth rates, yet declining. The same
has occurred with consumption, supported by a strong labor market. The unemployment rate
is near its fifteen-year low, which also reflects on the evolution of wages. Consumers'
expectations have improved in the past few months. On the investment side, the dynamism
of engineering works - mainly related to energy and mining projects - and the recent
recovery of building are worth signaling out. Other indicators are consistent with a
moderation of demand and output, such as the lower y-o-y growth rates of durable
consumption and imports. In addition, the slower pace of growth in employment, labor
income and consumer loans suggests a deceleration going forward. The Board's evaluation
is that output gaps are closed, which is also based on signs of a tight labor market and a
rapid normalization of core inflation.
Y-o-y CPI inflation is above the tolerance range, while core measures hover around 3%,
growing at a faster pace than in the last quarter of 2011 and forecasts in the December
Report. Still, as I just said, the level of core measures is consistent with our assessment of
the state of output gaps. The recent inflation trend is also explained by the behavior of
transport fares and the prices of fresh fruits & vegetables. The latter, probably affected by
climatic conditions, have followed a pattern that contrasts with their usual patterns and have
declined in the past few months. Market inflation expectations have risen, particularly for the
short term, but are still close to 3% over the policy horizon.
In this Report's baseline scenario we foresee that GDP will grow this year between 4% and
5%. This range is higher than December's, as it responds largely to the faster output growth
of late 2011 and early 2012. In addition, a number of the risks that were examined in the last
Report have moderated and the dynamic of the domestic demand adjustment will be
somewhat more gradual than was envisaged in December. This scenario assumes a
stronger impulse from abroad, associated with better terms of trade and external credit
conditions. Overall, the occurrence of temporary and limited frictions in international financial
markets is a possibility that cannot be ruled out. We also assume that growth will continue to
approach its trend levels - which the Board still estimates at 5% - and respond to the lagged
effects of the increases made to the MPR in 2011 (table 2).
The baseline scenario foresees a current account deficit in 2012 that is virtually unchanged
from the December forecast: 3.4% of GDP, after posting a deficit of 1.3% of GDP in 2011.
This enlargement obeys primarily to a bigger deficit of the trade balance, determined mainly
by the copper price, which is down from 2011. Furthermore, the oil price has risen from last
year. In trend prices, in 2012 the current account would post a deficit of somewhat less than
6% of GDP, not very different from that of 2011.
We foresee y-o-y CPI inflation hovering around 4% well into the second half of this year, to
later converge to 3% and remain there until the end of the projection horizon, this time the
first quarter of 2014. Y-o-y changes in core measures will continue to rise in the coming
months, and will converge to 3% more slowly than the CPI (figure 1).
This foreseen trajectory is based on the assumption that the propagation of supply shocks to
other prices will occur according to historic patterns. It also assumes that wages will be
adjusted on the bases of productivity and the inflation target, and that the RER will not
change much. On the fiscal side, the baseline scenario estimates that the structural deficit
will converge to 1% of GDP towards the end of the current Administration, as announced by
the authority and in conformity with the Fiscal Responsibility Act. Finally, it uses as a working
assumption that the MPR will follow a path comparable to the one that can be derived from
the prices of financial assets observed at the statistical cutoff of this Report (figure 2).
The baseline scenario reflects the events that the Board believes to be the most likely to
occur with the information at hand at the statistical cutoff date of the Report. However, there
are risk scenarios which, if materialized, may alter the macroeconomic outlook, with
implications on monetary policy. On this occasion, after assessing the alternative scenarios,
the Board estimates that the risk balance for both output and inflation is unbiased.
Although the risks in the international scenario are similar to those in previous Reports, their
possibility of occurrence is smaller. Still, structural issues persist in the Eurozone, so the
regained confidence in financial markets is yet to be consolidated. Repeated or intensified
financial stress episodes, in a context where banks are more cautious in their lending
decisions and capital requirements have increased, could deepen credit constraints,
complicating the growth outlook for the region and the world at large.
There are also persistent doubts about how China's slowdown will be. If more intense, its
effects will not only hinder world growth, but also pull down commodity prices, especially for
copper. Conversely, other economies could well perform better than expected, and offset
part of these effects.
The calmer external financial markets and the renewed appetite for risk have revived
concerns about how to accommodate the new capital flows into emerging economies.
Prolonging the strong monetary stimuli in the developed world, particularly in the U.S., may
foster an extension of global imbalances. Public indebtedness is elevated in the U.S. and the
high oil price hinders the resolution of its external deficit.
Now there is also the worsening of geopolitical tensions surrounding Iran which could
significantly affect the oil price, with negative effects on world growth and stronger pressures
on inflation.
In Chile, the persistence of strong domestic spending may alter the baseline scenario in two
ways. On one hand, it may intensify the inflationary risks now perceived, and increase the
propagation of supply-side shocks, like those in oil or fresh fruits & vegetables. It is also
possible that the velocity at which core inflation has increased is associated with tighter
output gaps than assumed in the baseline scenario. On the other hand, the sustained growth
in domestic demand may trigger a widening of the current account deficit and amplify the
effects of shocks from abroad on the Chilean economy, especially if accompanied by a falling
copper price.
Let me share with you some final thoughts.
Final thoughts
The macroeconomic environment just described has opposing effects, as there are
significant risks from different fronts.
As I said, the baseline scenario uses as a working assumption that the MPR will follow a path
comparable to the one that can be derived from the prices of financial assets observed at the
statistical cutoff of this Report. Any deviations away from this trajectory will depend on the
implications of domestic and external macroeconomic developments on the inflation outlook.
As I also said at the beginning, while risks for short-term inflation have increased, the risks
from abroad are still important and may cause significant damage to the Chilean economy.
Accordingly, the complexity of the present scenario calls for particularly prudent monetary
policy making.
On the side of domestic output, the projections we are now presenting show stronger growth,
mainly because recently output and demand have risen above December's forecasts. On the
prices side, our evaluation points at a higher level of inflation, especially in the short run. Our
view that output gaps are closed implies that economic growth should converge to its trend in
order not to cause imbalances that end up being very costly. Experience has taught us how
damaging an increase in inflation can be, particularly to the poorer population. It has also
taught us the importance of expenditure not growing excessively, in order to avoid
imbalances in the external accounts that erode our capacity to deal with shocks of different
kinds. This is especially true at this moment, when we are confronting these risks of the
domestic economy with doubts about how warranted this better mood of external markets is.
The situation of developed economies is very complex, and teaches a great lesson in how
phenomena that are overlooked and not addressed on time may end up taking a massive toll
on the people.
For all this, I want to stress the importance of proper management of the expectations about
the behavior of our economy and, of course, of our monetary policy. Prudent monetary policy
conduct means being prepared for any scenario, assessing them carefully, and adjusting
policy as required. Let me reiterate the commitment of the Board of the Central Bank of Chile
with a monetary policy oriented at keeping inflation low and stable. This is certainly the best
contribution we can make to the prosperity of our country.
Thank you.
Table 1
International baseline scenario assumptions
2010 2011 (e) 2012 (f) 2013 (f)
Sep.11 Dec.11 Mar.12 Sep.11 Dec.11 Mar.12
Report Report Report Report Report Report
(annual change, percent)
Terms of trade (*) 19.4 0.5 -5.3 -6.7 -5.3 -2.6 -3.5 -0.1
Trading partners 6.1 4.1 4.3 3.8 3.8 4.6 4.2 4.2
World at PPP 5.1 3.7 4.0 3.5 3.3 4.5 4.1 3.9
United States 3.0 1.7 2.0 1.8 2.1 2.8 2.2 2.3
Eurozone 1.9 1.4 1.2 -0.1 -0.3 2.1 1.0 1.0
China 10.4 9.2 8.3 8.2 8.1 8.7 8.5 8.5
Rest of Asia 7.7 4.3 4.5 4.4 4.3 5.0 4.8 4.8
Latin America (excl. Chile) 6.3 4.2 3.9 3.6 3.6 4.2 4.0 4.0
(levels)
LME copper price (US$cent/lb) 342 400 370 350 370 350 340 360
Brent oil price (US$/barrel) 80 111 108 107 121 106 102 115
(e) Estimate. (f) Forecast.
(*) September and December forecasts were done with national accounts with 2003 as the base year. Figures for 2010 and 2011 as well as the
March forecast, with the national accounts with 2008 as the base year, using chained indexes.
Sources: Central Bank of Chile based on a sample of investment banks, Consensus Forecasts, the IMF and statistics bureaus of respective country
or region.
Table 2
Economic growth and current account (*)
(annual change, percent)
2012 (f) 2013 (f)
Sep.11 Dec.11 Mar.12 Sep.11 Dec.11 Mar.12
Report Report Report Report Report Report
GDP 6.25-6.75 6.2 6.0 4.25-5.25 3.75-4.75 4.0-5.0
Domestic demand 9.1 9.5 9.4 4.5 3.7 5.3
Domestic demand (w/o inventory change) 9.7 10.2 10.3 5.4 4.8 5.8
Gross fixed capital formation 14.4 16.9 17.6 7.1 5.8 8.9
Total consumption 8.2 8.1 7.9 4.9 4.5 4.8
Goods and services exports 6.5 7.4 4.6 5.0 3.7 3.8
Goods and services imports 12.0 14.3 14.4 4.6 3.0 5.9
Current account (% of GDP) -1.0 -1.5 -1.3 -2.1 -3.3 -3.4
(f) Forecast.
(*) September and December forecasts were done with national accounts with 2003 as the base year. Figures for 2010 and 2011 as well as the March
forecast, with the national accounts with 2008 as the base year, using chained indexes.
Source: Central Bank of Chile.
Figure 1
CPI inflation (*) CPIX inflation (*)
(annual change, percent) (annual change, percent)
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
07 08 09 10 11 12 13 14
07 08 09 10 11 12 13 14
Dec.11 Report
Mar.12 Report
(*) Gray area, as from the first quarter of 2012, shows forecast.
Sources: Central Bank of Chile and National Statistics Institute (INE).
Figure 2
MPR and expectations
(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 13 14
Forward, Sep.11 Report
MPR Forward, Sep.11 Report
Forward, Dec.11 Report
Forward IPoM diciembre 2011 Forward, Forward Mar.12 Mar.12 Report Report
Source: Central Bank of Chile.