By many economic accounts, it took the big fiscal expansion associated with World War II to exit the Great Depression. Japan over the past 20 years We can also learn from the Japanese experience over the past 20 years. After attempting to expand production and avoid deflationary prospects in the late 1990s, monetary policy reversed course prematurely in the early 2000s as the inflation rate inched above zero; deflationary pressures soon reemerged and policy rates returned to zero by 2001.This experience was repeated again later in the decade. Indeed, it has only been over the past year – following nearly 20 years of stagnation – that we see the recent goal-oriented  14  6  See, for example, Kocherlakota (2013). BIS central bankers’ speeches  monetary expansion making significant headway in extracting Japan from below-target inflation. Recent European experience The recent European experience in 2011 is yet another example of premature tightening. Despite the headwinds from continuing debt-overhang and recent financial distress, European authorities in 2011 judged that the eurozone economy was emerging from recession and headline inflation was at risk to rise persistently above target. The European Central Bank (ECB) responded by raising policy rates in 2011. They soon had to backtrack as output in the eurozone fell again and inflation began to march down below target. Today, the eurozone faces continued economic weakness and an inflation rate that is just about 1/2 percent.

For a short presentation this could be too ambitious, so I will have to leave out some parts of the story. I will concentrate in some issues that I believe are essential for understanding the present state of affairs: global imbalances, the financial crisis, emerging economies’ growth and globalization, with its inflationary effects and “decoupling” phenomenon. I will continue with some policy lessons and implications on the Chilean economy. But first allow me to make some reflections on economic policy. Entrepreneurial success and failure are inherent to market economies. This is also true in financial entities. We know that in the corporate world rotation is high, with firms coming in and going out, and jobs being created and destroyed. This is at the cornerstone of Schumpeter’s destructive creation, and explains a substantial part of progress and productivity growth. However, there are negative externalities. Miscoordination and contagion problems, especially in the financial system, have the potential to amplify the cycles and transform destructive creation into destructive destruction. A financial institution in distress does not make the headlines, but when complications become systemic, the consequences can be very disturbing. It is thus crucial to prevent problems in one specific sector from spreading across the whole economy, with costly consequences. Hence the importance of safeguarding the economy’s financial stability. Until a while ago, when I was asked to speak about financial stability I normally discussed evidence from developing economies. We have learned than exchange-rate crises are costly per se, but if accompanied by a financial breakdown the cost duplicates.