the chilean economy and in providing a countercyclical fiscal boost. third, a high degree of commercial and financial integration with the rest of the world. although copper still accounts for a relevant portion of chilean exports, an important number of new markets for a variety of products have been opened thanks to both the unilateral efforts of trade liberalization and the significant spread of bilateral trade agreements with the major economic countries and zones. finally, a sound financial system, with globally integrated, well - capitalized, and adequately - regulated banks. actually, the regulation of the domestic banking system prevented some of the most notorious credit excesses that happened in advanced economies, or in the past of many emerging markets, including chile. banco central de chile ( 2007 ). see marcel et al. ( 2001 ) for a discussion of the budget rule. bis central bankers ’ speeches i will continue my presentation speaking about how all the shocks we have seen the last few years have affected the chilean economy and the policy responses we have put in place. then i will describe the recovery process and i will finalize presenting some thoughts on the lessons that can be drawn from our recent experience and some challenges i see for the future. the run - up to the financial bust by march 2008, bear stearns had already gone bankrupt and the risk of a higher stress episode at the world financial markets had increased greatly. due to the risks of a potential sudden stop if the financial crisis should worsen, and in a context of a severe appreciation of the chilean peso, in april, the central bank decided to start accumulating reserves through sterilized intervention. in chile, domestic demand grew rapidly in the run - up to the crisis. during 2004 – 2007, the average annual growth of output was 5. 3 %, while the average growth rate of domestic demand was 8. 1 %. private consumption grew 7. 2 % and investment 12. 1 %. the faster growth of demand than output is explained by a significant improvement in our terms of trade on the back of higher prices for copper and other commodities. in 2007, chile, like many other economies in the world, suffered a significant inflationary process, which only worsened during 2008 ( figure 2 ). perhaps the most remarkable component of this inflationary process was how strongly the increase in international food prices was transmitted domestically. this may have partially been due to chile ’ s high degree of commercial openness and little distortions in the price setting mechanism. another factor underlying

inflation pressures, and a deceleration of growth, was the higher cost of energy ( especially electricity ) that hit the chilean economy with particular strength ( figure 3 ). not only thermoelectric power plants had to operate with more costly inputs, but also unfavorable hydrological conditions and a severe shortage of natural gas implied that these more efficient sources of generation had to be replaced by diesel, in the context of rising oil prices. inflation rose from an annual rate of 2. 6 % in december 2006 to 9. 9 % in october 2008, when the rise of food and energy prices had also propagated to the rest of consumer goods. hence, the risks of inflation remaining above the target beyond the policy horizon grew strongly. consistently, monetary policy had a strong reaction. the monetary policy rate ( mpr ) was increased by 200 basis points in just four months, starting in june. by september 2008, before the collapse of lehman brothers, the central bank estimated that it would be necessary to increase the mpr further, even above market expectations. monetary and fiscal policy during the crisis as in most of the world economies, financial tensions in chile were severe after the collapse of lehman brothers. interest rates in both peso and dollar markets posted substantial increases in the most stressful times from mid - september to mid - october 2008 ( figure 4 ). the central bank acted quickly, providing peso and dollar liquidity facilities to the financial system to mitigate liquidity tensions, but also to ensure financing in foreign currency should foreign loans become scarce. also, the foreign exchange reserves accumulation process was cancelled. local money market conditions normalized rapidly, over a period of weeks. the additional liquidity facilities put in place were not used extensively by financial institutions, reflecting their sustained access to external markets. beyond the stressful episodes in local money markets, the global confidence crisis that swept around the world was very important in chile. the events of developed financial markets prompted a deep and widespread revision of investment and spending plans of businesses and households, bringing expenditure to a halt. domestic demand and economic activity dropped significantly and lending standards tightened ( figure 5 ). bis central bankers ’ speeches the inflation outlook changed radically, and monetary policy reacted forcefully. first, by communicating a change in outlook and the bias of monetary policy, inducing an important decline in market rates at all horizons. then, in january 2009, with a clearer assessment of the reduced inflationary pressures, the mpr was lowered by 100 basis points