In 2001, the government adopted a balanced budget rule that constrained public expenditures, to ensure that the structural balance, measured as a share of GDP, met a specific target or range (De Gregorio 2009b; Llédo et al. 2017). The fiscal targets are were then regularly adjusted in line with changes in potential growth and forecasts of longterm copper prices.<sup>3</sup> Two independent committees, one focused on potential output and the other on copper prices, advise on the practical calculation of the structural balance.

Results. Despite some large fluctuations of inflation around the target range, long-term inflation expectations in Chile have been remarkably well anchored since the adoption of inflation targeting, and the sensitivity of inflation expectations to shocks is among the lowest in EMDEs. During the early years of the inflation targeting regime, inflation fell and became less volatile. Even under the partial inflation targeting regime, there was a sustained decline in headline inflation and inflation expectations (Figure A.5.2). Average inflation fell from 15.5 percent in 1991-94 to 5.7 percent in 1995-98. Moreover, the exchange rate pass-through to inflation dropped significantly starting in the mid-1990s and continued falling after the adoption of formal inflation targeting in 1999 (SchmidtHebbel and Tapia 2002).

A period of low inflation in 2003 and 2004 challenged the credibility of Chile’s inflation target. In the second half of 2003, Chile experienced a significant and unexpected deceleration in inflation, as the peso appreciated and competition in the retail sector intensified (Central Bank of Chile 2004). Although survey-based inflation expectations remained close to the target of 3 percent (that is, well anchored), five-year-ahead, marketbased inflation expectations declined significantly.

Long-term inflation expectations varied only slightly during the global financial crisis, despite large gyrations in actual inflation. From mid-2007 to late 2008, headline inflation in Chile experienced upward pressure from international factors—namely, rising food and energy prices. Headline inflation peaked at 9.9 percent (year-on-year) in October 2008. Although short-term expectations increased significantly as inflation rose, the reaction of five-year-ahead expectations was much more muted, reaching a high of 3.2 percent in the second half of 2008. Thereafter, as the global financial crisis deepened and global activity slowed, inflation in Chile rapidly became negative, prompting a 775 basis point reduction in the policy interest rate in the seven months to July 2009 and the introduction of several liquidity support measures. Yet five-year-ahead inflation expectations dropped only slightly, to 2.9 percent in the second half of 2009, suggesting that expectations were by that point very well anchored.

Inflation rose well above the target band in 2014-16, due to peso depreciation following the slump in copper prices. However, excess capacity in the economy and a cautious monetary policy stance helped reduce inflationary pressure, and by mid-2017, inflation began to slightly undershoot the target band. Food price deceleration and, initially, peso appreciation, contributed to the undershooting. Through these fluctuations, long-term inflation expectations were impressively stable.

> 3 Prior to 2015, long-term molybdenum prices were also considered in setting structural balance targets. Llédo et al. (2017) provide additional details.

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