MONETARY POLICY REPORT
PRESENTATION BEFORE THE HONORABLE
OF THE
SENATE REPUBLIC
Mario Marcel
Governor
Central Bank of Chile
6 September 2017

The Monetary Policy Report of September 2017 can be downloaded from http://www.bcentral.cl/en.
[INF*RES*AS]
Introduction
Mr. President of the Senate, Senator Andrés Zaldívar, honorable senators, ladies,
gentlemen,
Thank you for inviting the Board of the Central Bank of Chile to present our September
Monetary Policy Report. As is the case every September, its publication coincides with
the annual report that, as provided for in the CBC's Organic Law, we must submit to the
Senate. The report I will be summarizing for you now depicts the Board's vision about
the recent macroeconomic and financial developments in Chile and the world, together
with prospects and implications for the conduct of monetary policy. It also includes the
CBC's financial results for the first half of the year, plus the results of international
reserves management and a summary of the main decisions adopted by the Board this
year to date.
This presentation will describe two additions to the traditional report, namely an analysis
of the determinants of trend GDP in Chile -as a supplement to the Report- and some
refinements that the Board has decided to apply to the monetary policy process,
summarized in a box alongside the main text.
With these additions, we reaffirm the Board's decision to not only disclose rigorously
how the institution is managed, but also use its autonomy to improve the quality and
transparency of its processes beyond what it is strictly required by law.
The Monetary Policy Report
In recent months, inflation and growth were below the estimates in the June Report.
However, the main differences were related to factors that we consider to be transitory,
in particular supply-side factors that affected the performance of activity and the level of
certain prices. For this reason, neither the outlook for the economy for the next two years
nor the general orientation of monetary policy, differs much from the projections
contained in it.
In the baseline scenario I will examine in a moment, core inflation -the CPIEFE- will
gradually return to 3% as from mid-2018, after several months around 2%, while headline
inflation will rise somewhat faster, as prices of its most volatile components return to
their historical patterns and market expectations about the world prices of fuel and
foodstuffs are confirmed.
We expect GDP growth to pick up beginning in the second half of this year. With this,
the activity gap should remain fairly stable for some time, to begin closing gradually
towards the second half of 2018.
In this context, the Board of the CBC has kept the monetary policy interest rate (MPR)
at 2.5% and in the baseline scenario it expects to maintain a significant monetary impulse
throughout the next two years, with an MPR that, in baseline scenario conditions, should
remain around its current levels and start approaching neutrality only when the economy
begins to close the activity gap.
Now, let me describe in further detail what we estimate to be the most likely
macroeconomic scenario for the coming quarters and its related risks.
At July, annual CPI inflation descended to 1.7%, thus accumulating a sharper fall than
was foreseen in June. Its core component has evolved in line with forecasts, to near 2%
annually, and continues to reflect slightly negative annual variation rates for goods
inflation, and above 3% for services (figure 1). The evolution of the more volatile prices,
particularly of fresh fruits and vegetables, has been a major factor in inflation falling
below expectations. This is mainly associated with the unusual seasonal behavior that
some products exhibited this year. Going forward, these prices are expected to be in line
with historic patterns and help bring inflation to the target. Still, by their nature, these
products can always be a source of inflationary surprises.
In the second quarter, GDP rose 0.9% annually, with other sectors growing 1.1%, less
than expected in June. The economy was affected by significant differences in the number
of days worked, including an irrevocable holiday in April, whose impact was higher than
estimated. In fact, in annual terms, the seasonally-adjusted series of total and other GDP
grew more than the original series: 1.3% and 1.5% respectively (figure 2). Second-quarter
activity was also influenced by some one-time shocks that hit the manufacturing industry.
Even so, the stronger impulse of the more consumer-related activities, such as trade and
services, continues to stand out, while some investment-related sectors, such as
construction and some business services, have weakened further.
Total domestic demand increased 3.9% annually in the second quarter, with significant
inventory build-up, partly responding to replenishments after a long period of depletion.
However, there are signs that it may have been more than the state of the cycle would
suggest, which could result in reduced imports in the coming months.
In turn, final domestic demand -excluding inventories- was somewhat lower than
expected, and continued to account for the dissimilar behavior of consumption and
investment (figure 3). Consumption shows a somewhat stronger growth, with
improvements in several of its fundamentals. One important concern about the economy
early in the year was the deterioration of the labor market, in particular the salaried
employment drop in annual terms. This was one of the risk factors that led us to accelerate
the MPR reduction at the beginning of the year. This risk has faded in recent months.
Indeed, in the last few months salaried employment has resumed its positive annual
variation rates and some of its quality indicators have ceased to deteriorate. Among them,
an increase in private employment under contract and a decrease in involuntary part-time
work are worth singling out. Self-employment, although growing at a higher rate than its
salaried counterpart, has slowed down and the unemployment rate is now near its levels
of a year ago, slightly higher than at the end of the first quarter (figure 4).
Nominal wages' annual growth rate stopped falling. In June they expanded between 4.4%
and 5.0%, compared with rates of 5.5% and 6.0% in June of 2016. Real wages increased
their annual variation, mainly due to low inflation. All this contributed to real incomes,
measured by the real wage bill, slightly increasing their annual growth rate, to 3%. Add
to this that consumer expectations have improved systematically in the last five months,
although they are still in pessimistic territory. Moreover, the cost of credit is at record
lows, consistent with the expansionary instance of monetary policy (figure 5).
Unlike consumption, investment remains weak, especially its construction and works
component, which has steepened its annual fall from mid-2016, hand in hand with a drop
in housing investment and reduced public investment. Investment in machinery and
equipment, despite some annual deceleration from the previous quarter, continues to
outperform recent years, especially after discounting the non-regular transportation item,
thus accumulating a nine-month string of positive growth rates (figure 6).
On the external side, a more favorable scenario for the emerging world and Chile has
been strengthening. The terms of trade have improved, with copper prices above $3 per
pound in recent weeks. This, in a context in which the price of oil, with fluctuations and
considering the Brent - WTI average, is slightly below those at the cutoff date of the
previous Report. The copper price rise has coincided with a well-stocked market despite
supply-side problems, in the context of a weak dollar. China's low interest rates and better
performance lend support to higher prices in the short term. In any case, although its price
is not expected to remain stable, it is projected to average more than June's estimates. In
our baseline scenario, the pound of copper should trade at an average of $2.75 in
20172018, and at $2.70 in 2019.
Stronger economic growth in the developed world has also consolidated. The United
States, like it did several quarters ago, shows a good performance of consumption and a
dynamic labor market. Europe has seen a strong recovery in its growth rates, all across
the economies making up the group, beyond the differences that persist among them in
variables such as the size of the gap and the unemployment rate. Growth in Japan
surprised positively, and expectations have been revised upwards.
Meanwhile, inflation has tended to subside and the monetary authorities of the developed
world have made no big changes to their monetary policy strategies. Nevertheless, the
market has been incorporating some moderation into its vision of the US monetary policy
and some more intensity in that of the Eurozone, which partly explains the global
depreciation of the dollar.
Emerging currencies have benefited from the weak dollar, the better prices of
commodities and increased risk appetite. Comparing the statistical closures of this and
the previous Reports, the peso has appreciated by around 4.5%, which, in real terms,
translates into a decrease of approximately 3.5% of the real exchange rate. Thus, at the
last cutoff date it was fluctuating around 90 in its 1986 = 100 measurement, lower than
its averages of the last 15 or 20 years. Moreover, in the days following the statistical
closure, the peso has continued to appreciate in both nominal and real terms. As a working
assumption, the baseline scenario of this Report assumes a slight depreciation in real
terms over the projection horizon (figure 7).
Turning to the performance of the emerging economies, in the first half of the year China
grew 6.9% annually, exceeding expectations. These figures raise the baseline scenario
estimate, although some moderation in activity is assumed for the second half, in line
with the latest data on manufacturing output, retail sales and investment (figure 8). In
Latin America, the recovery of activity has been slower, with poor performance of
investment and sectors unrelated with natural resources. This, despite the favorable
external scenario and the fact that the lower inflation has allowed to boost the monetary
impulse, which is partly associated with idiosyncratic factors.
Although somewhat less severe, the problems of fiscal consolidation in Brazil and
Argentina, the political definitions during this and next year, concerns about the future of
NAFTA and its effects on Mexico, among others, continue to worry. In Colombia, the
decrease in consumption resulting from the VAT increase and the fragility of its labor
market, have resulted in slower growth than foreseen by the market. Activity in Mexico
has been more resilient than the market expected, beyond the lower performance in the
margin due to seasonal factors. In Peru, GDP growth has tended to stabilize and shows
some signs of recovery. This, after the weakening in the second half of last year, partly
due to the El Niño phenomenon and paralyzed infrastructure projects. There is some
improvement in activity data from Brazil, but from very negative figures and with still
quite low growth rates.
Thus, our baseline scenario projects that our trading partners' activity will be slightly
better than we thought in June and that terms of trade will be higher, all within a context
of favorable financial conditions. Thus, the Chilean economy will receive a stronger
impulse from abroad over the projection horizon (table 1).
As is the norm in the Report we publish every September, the baseline scenario includes
our annual revision to trend and potential GDP estimates for the Chilean economy. These
are summarized in the Report's box V.1. Also, this time around, we have attached to the
Report a supplement describing a body of background information on the determinants
of and perspectives for Chile's trend growth over the next 30 years. I will come back to
the contents of this document in a few minutes.
Our estimates suggest that Chile's trend GDP growth over the next ten years is in the
range of 3% to 3.5%, quite comparable to our estimates a year ago. This range implies,
among other things, that investment again grows in line with GDP; that the productivity
of sectors other than natural resources grows near its average of the last 20 years; and that
immigration and increasing female participation partially offset the effects of the aging
population on the labor force.
With regard to potential growth, at the shortest terms, investment and productivity show
below-trend growth rates, so potential growth is lower than trend. Thus, potential GDP
growth is now estimated to be around 2.5%, compared to the 2.5% to 3.0% we estimated
in September 2016. With this, the current activity gap is somewhat narrower than
previously estimated, even considering that the evolution of GDP has also been somewhat
lower (figure 9). For the purposes of monetary policy, the evolution of the activity gap is
still consistent with an economy needing an important monetary impulse throughout the
projection horizon. In addition, the Board continues to estimate the neutral interest rate
to be between 1% and 1.5% in real terms.
In our baseline scenario, we continue to forecast that GDP will gradually regain higher
expansion rates, backed by favorable external conditions, the end of the mining
investment adjustment, no big macroeconomic mismatches and a clearly expansionary
monetary policy stance. This scenario also assumes that fiscal policy will remain on its
consolidation path, expressed in the immediate future in the upcoming budget aligned
with the Administration's commitments. All this in a context in which potential growth
steadily approaches trend-consistent levels.
Accordingly, our projections show no major changes compared to our June estimates.
For this year, we foresee that the economy will grow between 1.25% and 1.75% (1% to
1.75% in June). For 2018, we continue to expect growth to pick up, to a range between
2.5% and 3.5%, identical to our June forecast. On the expenditure side, our growth
forecast for private consumption is slightly adjusted upward in 2017, considering the
rebound of the real wage bill observed so far, the recovery of confidence indicators, the
necessary replenishment of durable goods inventories and an appreciation of the real
exchange rate. In investment, the downward adjustment of projections for 2017 stems
primarily from construction, including the mining, infrastructure and housing
components. This latter one because of the high stock of new homes for sale that still
persists. Thus, by 2017 a contraction of this component of gross fixed capital formation
is expected, while the machinery and equipment component is slightly adjusted upwards,
reflecting the actual data to date and also the steady growth in imports of capital goods
excluding non-regular transportation.
Externally, exports are forecast to contract this year as a result of some supply-side shocks
in manufacturing and mining downtime in the first half of the year, which has already
been reflected in lower shipments from the sector. However, as these factors are estimated
to be transitory, by 2018 these shipments should post a visible recovery. For the purposes
of the trade balance, the aforementioned increase in the terms of trade, in particular the
higher price of copper, translates into an increase in valued copper exports, which more
than offsets the lower volumes of non-mining exports. However, in a context of higher
copper prices and lower costs in the mining industry, rents paid abroad increase, so in
2017, the current account has a slightly bigger deficit than was forecast in June (table 2).
Inflation has been below expectations, standing at 1.7% annually in July. Although the
evolution of core inflation was not very different from projections, the unusual drop in
the fruits and vegetables component during these months has taken a little more than half
a percentage point off annual inflation. Added to this is the significant appreciation of the
peso since June, intensified in recent weeks. Thus, CPI inflation will end the year at 2.4%
and the CPIEFE at 1.9%, both below June's forecasts. Going forward, core inflation is
expected to fluctuate around 2% until mid-2018, heavily influenced by the effects of the
recent peso appreciation, to gradually return to 3% thereafter. Meanwhile, as fruits and
vegetables prices resume a similar dynamic to that of their historical averages, the CPI
will return to the target by the second half of 2018. As I mentioned, this trajectory is
based on the RER depreciating slightly over the projection horizon (figure 10).
As usual, a number of internal and external elements represent risks to these projections.
Abroad, an ongoing concern is how the financial markets will respond to the monetary
policy strategies of the main central banks of the developed world. After several years of
highly expansionary monetary conditions, the economies have closed-or are on their
way to close-their gaps and it is natural for monetary policy to begin to normalize, both
in its more (rates) and less (balance sheet) conventional aspects. This entails risks because
of the unprecedented timing and gradual pace of the process and its differences with
market expectations.
In the United States, there's also the doubts about fiscal management and its effects on
growth, interest rates, and asset prices in general. Add the concerns about whether the
recent low inflation figures in several developed countries are one-time or rather
systematic events, plus risks associated with recent geopolitical tensions. However, we
cannot rule out that, given the good numbers of recent quarters, we see a faster recovery
of developed economies.
In the emerging world, the main source of risks continues to be the Chinese economy.
Despite good first-half results and policies implemented, doubts persist about imbalances
in a number of Chinese markets. There is also the uncertainty surrounding the path that
the reforms agenda will take once the Chinese Communist Party Congress concludes. In
Latin America, the landscape has not changed much and political risks remain the main
source of uncertainty.
The copper price surpassed US$3 per pound at the statistical cutoff, but the baseline
scenario assumes that it will stand near US$2.75 during the next two years. Should the
present price last, it would have positive effects on domestic activity and expenditure. At
the same time, it could strengthen the peso and lower short-term inflation.
The implications for monetary policy of such a scenario are not straightforward. Although
in the short term inflation is reduced, the greater dynamism of the economy could imply
a somewhat faster closure of the activity gap in the projection horizon. This crossroads,
in a way, reminds us of the sharp peso depreciation between 2013 and 2015. In those
days, when the exchange rate accumulated an increase of around 45%, annual CPI
inflation was above 4% for several quarters.
At that time, monetary policy did not react to this increase in inflation by raising the
MPR, understanding that it would have a significant but transitory effect on prices. In
fact, what the economy needed was a greater monetary boost that would help offset the
negative effects of the end of the commodity super-cycle and the weakness the economy
had shown in recent years. In this sense, although the recent appreciation of the peso is
an important development and will undoubtedly affect the evolution of inflation in the
short term, as reflected in the projections that I have just shown, its implications for
monetary policy are not evident as long as its direct or indirect effects do not imply that
the convergence of inflation to the target in the policy horizon is compromised.
About our domestic economy, the baseline scenario assumes that the factors that have
reduced activity and inflation in recent months are transient. However, their persistence
may be different than anticipated. On activity, a fraction of the lower growth responded
to more persistent investment-related factors. This may be accentuated, for example, if
confidence indicators regress. In any case, it cannot be ruled out that the economy may
return to higher growth rates faster than assumed in the baseline scenario. This,
considering that the labor market has not deteriorated any further, the cost of credit is low
and expectations have improved somewhat, which could lead to more dynamic
consumption.
Inflation has fallen beyond forecasts and is now below 2%. Expectations at shorter terms
are down from the cutoff date for the last Report, but at longer terms they show no major
changes and remain anchored to the target. However, various factors may result in a
sharper or longer-lasting drop, which could affect price formation over longer terms and
inflation expectations.
In this context, the Board estimates that the risk balance is unbiased for activity, and for
inflation it is biased downward in the short term, but unbiased in the medium term.
As a working assumption, our baseline scenario estimates a similar monetary impulse as
in June, i.e., the MPR remaining fairly stable and beginning to move up towards neutral
only after the economy starts closing the activity gap. Thus, monetary policy will remain
expansionary through the entire projection horizon. As always, we will be watchful for
any deviations from the baseline scenario that warrant moving the MPR. As I just said,
in the short run inflationary risks are biased downwards. If it happens, it may affect
convergence to the target, in which case monetary policy will need to be even more
expansionary.
New institutional developments and contributions
Dear senators, I am submitting to you this, my first annual account as Governor of the
Central Bank. I head an institution that has more than a quarter of a century of
autonomous history and that, over this time, has built and consolidated a technical
reputation that has allowed for the correct performance of its functions, transforming it
into an institutional reference in the public apparatus and in the group of central banks of
emerging countries. This has occurred to a large extent thanks to our important
contribution to the country's macroeconomic stability.
Traveling this road has not been easy. At the outset, the mere idea of granting autonomy
to the Bank cast a heavy blanket of doubt, not only because of the novelty of the scheme,
but because it was difficult to dissociate its potential benefits in the fight against inflation
from the political circumstances of its origin. However, the Bank's actions and its first
monetary policy decisions made it possible to enhance the legitimacy of the Bank. This
behavior has been extended and deepened over time, largely on the initiative of
successive Central Bank boards. The adjustments to the monetary policy framework,
increased attention to issues of financial stability, efforts to improve the market
orientation of its policy decisions and the adoption, by its own initiative, of higher
standards of transparency and accountability are expressions of this.
Thus, the capital invested by the Bank in seriousness and commitment to the inflation
target and financial stability has contributed enormously to provide spaces of
independence to its monetary policy making. At the same time, the institutional autonomy
of the Bank has not hindered dialogue and coordination with the Executive, through the
Minister of Finance. Nor has this autonomy been translated into greater rigidity, but has
provided an institutional arena within which it has been able to adapt, in a timely and
flexible way, to new challenges, safeguarding the necessary independence to carry out its
work.
The biggest challenge for an autonomous institution is to not stay behind the new
demands of its environment, acting with timeliness and effectiveness to meet its
institutional objectives in new circumstances, gaining the trust of the public. This
confidence is far from being a sure asset. In today's ever-changing world, where
confidence can be lost in a wink, we must work day after day to preserve it, especially
considering the challenges that we face, both economically and socially.
In this context of greater transparency, better communication and contribution to the
people's needs, I want to mention two elements that accompany this Report: a report on
the determinants of the trend growth of the Chilean economy and a set of modifications
to the monetary policy decision-making process.
Determinants of the Chilean economy's trend growth
As I said a while ago, alongside this Report we have published a document summarizing
a body of research that our technical teams have made on the determinants of long-term
economic growth. Although these investigations date back many years, they have tended
to remain at an academic level. However, because in recent years our economy has
slowed down quite significantly, it seemed to us on the Board that it would be appropriate
to make an additional effort to consolidate our analysis, in an area that is not only key to
adequately achieving the objectives mandated by the law, but also of general interest for
the country.
The document I am presenting today is the result of six months of review, updating and
consolidation work of many studies carried out at the Central Bank, combined with
incoming new empirical evidence that enrich our knowledge of the Chilean economy. It
provides an in depth analysis of the medium-term trend growth of Chile in the horizon
spanning from the years 2017 to 2050, with a special focus on the GDP growth projection
for the next ten years.
This document projects the evolution of the productive factors (labor and capital) and
total factor productivity (TFP) for sectors other than natural resources, while for the latter,
the projection of its expected evolution is updated in the light of diverse sectoral
background. It includes both the study of the history of the variables and a cross-country
comparison, which allows us to look at the Chilean experience in the context of other
countries that experienced our current levels of development before us, showing us what
we can expect in the future. It also stresses the major importance of productivity, both in
explaining current differences in income levels with the developed world, and in
projecting future growth. Therefore, special care is given to analyzing the evolution of
TFP, providing new evidence on the importance of generating the proper conditions for
an efficient allocation of resources.
Primarily, we estimate that a range around 3% to 3.5% is reasonable to place trend GDP
growth for the ten years ahead of us. This range for trend growth inputs the assumptions
that natural resources sectors will grow around 2% on average, and the other sectors will
grow near 3.4%.
About this, estimates indicate that the increase in labor, understood in a broad sense, will
contribute about 0.8% to growth in other sectors' GDP. Behind this estimate is the fact
that improvements in human capital, the incorporation of women to the labor force and
immigration will help compensate for the negative effect of the aging of the Chilean
population and the tendency towards reducing the number of hours effectively worked
that comes with development (figure 11).
The projection assumes a relatively neutral role for capital, in the sense that it expands at
the same rate as Other GDP. This assumption is consistent with the capital / product ratio
remaining at levels close to its historical average, a stylized fact that is also present in
other countries. For this, however, it is necessary for the investment rate to return to
values consistent with potential growth.
Finally, our projection assumes that the total factor productivity of other GDP will resume
growth around its average of the last twenty years, an important but clearly possible
challenge. Recovering the trend growth of productivity in sectors other than natural
resources will be especially important, given the downward trend of natural resources,
associated mainly with the fall in mineral ore. Indeed, the data show that, beyond the
difficulty of calculating productivity by sector, the negative effect of the decline of
mining ore has taking its toll on this industry (figure 12).
The evidence from Chile suggests that there are important inefficiencies in resource
allocation across firms and that there would be first order gains from measures aimed at
improving them, which, unlike the case of human capital, could generate gains sooner.
To back this last analysis, the document provides some international comparisons on
productivity, microeconomic evidence on how the productivity of firms evolves, and its
degree of dispersion. In particular, from a comparative perspective, although Chile's
productivity appears to be aligned with its GDP per capita, it is about 60% that of the
United States and less than that of the richer OECD countries, which implies that there is
great room for improvement (figure 13).
In Chile, as in many other economies, there appear to be significant gains from fostering
a better allocation of productive resources, helping the more efficient firms to grow and
the less efficient to shrink and eventually exit the market. As can be seen in table 3,
resource reallocation is an important source of TFP growth. For this, it is essential to have
flexible labor markets that allow adjusting the endowment of companies when necessary,
developing the financial system to direct resources to where the good ideas are and
implement rules that facilitate the creation and dissolution of companies.
These figures are similar to those presented in previous years, reflecting that the Board
has not changed its view on the medium-term productive capacity of the Chilean
economy. However, we cannot ignore the fact that, because in recent years the growth
rates of investment and productivity have been below their trend levels, short-term
productive capacity has suffered. Actually, the Board estimates that the potential growth
of the economy is now around 2.5%, a little short of previous estimates.
Adjustments to the monetary policy making process
Another area where we are making progress is in the transparency and communication of
our monetary policy decisions. The Bank conducts its monetary policy in an inflation
targeting framework, which, to function correctly needs to properly communicate its
actions and the reasons behind them, as well as a good diagnosis of the evolution of the
economy, locally and internationally. The adoption of these decisions and their
communication are structured around the Monetary Policy Meetings and the Monetary
Policy Report, whose organization, priority, content and dissemination are currently
based on procedures and standards that were mostly established in the first half of the
2000s.
After a thorough internal assessment based on accumulated experience and international
best practices, the Bank Board has decided to make some modifications to its monetary
policy decision-making and communication process.
Essentially, the number of Monetary Policy Meetings (MPM) is reduced from twelve to
eight per year, to align them with the most common practice among the central banks of
low-inflation countries (figure 14). In this new scheme, meetings will be held roughly
every six to eight weeks, in January, March, May, June, August, September, October and
December of each year. In addition, the meeting will be extended from one day to one
day and a half, starting the afternoon before the day of the policy decision announcement,
thus giving the Board more time to discuss the background information and analyze the
monetary policy options.
This will give more time to gather information between meetings and to evaluate the
impact of the different economic indicators on the baseline scenario, allowing for a more
robust analysis of the recent evolution of the economy.
The communication and the minutes of the Meetings is also being changed, in the sense
of backing the decision having more information at hand than we currently do. Thus, the
press release will be extended to include the main antecedents of the recent behavior of
the economy, the grounds on which the Board based the decision and the voting. The
minutes, meanwhile, following a usual practice in inflation-targeting central banks, will
provide additional information on the Board's discussion, which may be useful for the
public to better understand its