After the Second World War the abandonment of the “golden standard” changed things completely. The introduction of the fiat money changed the monetary policy framework dramatically, forcing the financial stability issues to take back seats in the central banks considerations. There were two main reasons for financial stability being less of a worry. First, by using the fiat money the role of the lender of the last resort was not limited anymore. The central bank could lend to commercial banks as much as they wanted to borrow, just printing new money. There was no need to hold a parity to anything. Second, many central banks faced serious troubles in order to meet their ultimate target, the price stability, within the new fiat money environment. Therefore the policy focus shifted and huge effort was concentrated on finding a new appropriate policy framework. The situation was even more complicated due to the fact that both aforementioned points were closely interdependent. To illustrate this point, let's assume that there was an inflationary pressure which caused redistribution disturbances to the financial system as it led to the redistribution of wealth from lenders to borrowers. The central bank either had not established the appropriate framework for dealing inflation yet, or even worse, inflation had not been viewed as an undesirable phenomenon. On the other hand, the central bank was ready to fulfil its role as a lender of last resort. But saving the commercial banks from imminent bankruptcy further increased inflationary pressures. At the end this caused kind of inflationary trap.

In addition, short-term figures known since the publication of our last Report point at milder short-term inflationary prospects. The latest output indicators have been more negative than we foresaw in May. Although for the moment this does not alter our forecast of a recovery of activity and demand in the second half of this year, it does present a scenario where output gaps are wider than estimated and, therefore, inflationary pressures are reduced. The labor market also continues to reflect deteriorated macroeconomic conditions, with steadily increasing unemployment although with a marginally moderated drop in employment. May’s inflation was negative beyond expectations, especially its underlying components. Year-on-year CPI inflation, after many months, returned to the tolerance range of the inflation target (figure 2), but is expected to continue to fall and even cross into negative territory in the latter part of the year. Inflation expectations derived from various surveys also show some declines in the last few months. Recent public discussions have centered on parity movements. The real exchange rate is, without any doubt, a key variable in resource allocation and in the balance between saving and investment. Unlike conjunctures of past decades, in particular those of the mid-1980s, the Chilean economy has dealt with the complex global financial situation from a much sounder standpoint. The sudden global collapse of late last year found us with no big currentaccount or fiscal deficit, nor with a high external debt requiring strong fiscal adjustments with substantial real depreciation that would place the economy in a sustainable medium-term path.