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April 20-21, 2006

The Real Exchange Rate in Chile Rodrigo O. Valdés Central Bank of Chile XXIII Meeting of the Latin American Network of Central Banks and Finance Ministers. April 20-21, 2006. Four Bottom Lines.

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April 20-21, 2006

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  1. The Real Exchange Rate in ChileRodrigo O. ValdésCentral Bank of ChileXXIII Meeting of the Latin American Networkof Central Banks and Finance Ministers April 20-21, 2006

  2. Four Bottom Lines • There has been substantial peso appreciation, but not particularly unusual in a historical perspective. • (Current) Changes in fundamentals can explain a large XR movement: • Theoretically • Empirically • Obvious public concerns reflect the different jobs the XR performs in a small open economy. • Policy responses have mitigated the peso appreciation. C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  3. Is It the Peso, the Dollar or Both? C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  4. Real Exchange Rate in Chile: A Longer Perspective Source: Central Bank of Chile C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  5. Real Exchange Rate in Chile: A Very Very Long Perspective Source: Updated from Calderón and Duncan (2003) C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  6. An Obvious Suspect: Large Swings in Fundamentals Source: Central Bank of Chile C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  7. Suspects Fit in Theory RER response to a permanent 10% increase in copper price under alternative specifications of MAS, a DSGE Model of the Chilean economy MAS: microfounded DSGE model for the Chilean economy. Commodity sector that takes prices as given, important share of government in commodity sector, sector demands capital, government expenditure bundle has more non traded goods . Imperfect pass-through, sticky prices, and wages indexed to past inflation. Imperfect capital mobility. Policy rule for the real interest rate. Source: Soto and Medina (2005a) C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  8. Suspects Fit in Theory (cont.) MAS responses to a transitory 10% increase in copper price Source: Soto and Medina (2005b) C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  9. Suspects Fit Empirically – High Frequency Analysis Source: Selaive (2006) C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  10. Suspects Fit Empirically – Quarterly BEER Model Source: Caputo and Dominichetti (2005) C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  11. Is It a Public Concern? C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  12. Behind the Concerns The XR has at least three jobs: • Relative price signal to soften the cycle • Relative price signal to foster X-led growth • Signal to correctly price risks and limit vulnerability Some issues: • For (iii) need some ex ante volatility • (i) and (ii) mix well in bad times, but not in good ones • Transitory, permanent and long-lasting shocks • Policies have different comparative advantages in affecting these jobs. C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  13. Policy Responses I Fiscal Policy: • Structural surplus fiscal rule indicates that 100% of excess revenues are saved (2005 surplus = 4.8% of GDP) • Not spending can have major effects (Example: ) • Current challenge: financial management of these surpluses. C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  14. Policy Responses II Monetary and XR Policy: • Full-fledged IT + free floating XR renders a natural buffer, as monetary policy is contingent. • When XR is off what the authorities consider as fair valuation they may hint it: • January Monetary Policy Report baseline scenario included a “moderate depreciation” and an assessment of long run RER. • “Verbal” intervention through public statements. • Intervention is part of the toolbox. Need to spot misaligment, evaluate that it is costly and that intervention has a chance of success. C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  15. Fiscal Rule and a ToT Shock Responses to a 4% increase in government income (Source: García and Restrepo, 2006) C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

  16. References Calderón C. and R. Duncan (2003), “Purchasing Power Parity in an Emerging Market Economy: A Long-Span Study for Chile,” WP N°215, Central Bank of Chile, June. Caputo, R. and B. Dominichetti (2006), “Revisión Metodológica en el Cálculo del IPE e Implicancias sobre los Modelos de Series de Tiempo para el TCR,”Economia Chilena, Vol.8 N°1, Central Bank of Chile, April. García C. and J. Restrepo (2006),“The Case for a Countercyclical Rule-based Fiscal Regime,”mimeo, Central Bank of Chile. Selaive, J. (2006), “Nominal Exchange Dynamics in Chile,”mimeo in progress, Central Bank of Chile. Soto, C. and J.P. Medina (2005a), “Proyecto MAS: Modelo para Análisis y simulaciones,”mimeo, Central Bank of Chile. Soto C. and J.P Medina (2005b), “MAS: A New DSGE Model for the Chilean Economy,”mimeo, Central Bank of Chile. C E N T R A L B A N K O F C H I L E R E A L E X C H A N G E R A T E I N C H I L E

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