Reaching One-Digit Inflation: The Chilean Experience

Vittorio Corbo

Journal of Applied Economics, 1998, vol. 1, issue 1, 123-163

Abstract: The main purpose of this paper is to analyze the process by which Chile was able to reduce inflation during the 1990s. During this period, inflation was gradually reduced from close to 30% per annum in 1990, to only 6% in 1997. The paper concludes that three factors were important in helping to accomplish this reduction. First, the independent Central Bank and its tough action early on -to convey the message that it was ready to stand behind its core objective (to reduce inflation)- helped to shape inflationary expectations and, in the event, led to lower wage inflation and ultimately a lower path for core inflation. Second, the Bank's restrictive monetary policy, and the foreign exchange intervention policies associated with it, resulted in a nominal exchange rate trajectory much below what would have been observed under a PPP rule adjusted for differences in productivity. This result was reinforced by the low credibility of the band, reflected in the effect on the observed rate of the location of the exchange rate within the band. Third, the higher rate of growth of labor productivity, given the wage equation, resulted in a lower rate of growth of the unit cost of labor than would have obtained otherwise. Of these three effects, the first, that is, the enhanced credibility of the new policy operating through the formation of inflation expectations, was found to be the most important factor in the successful reduction of the inflation rate.

Date: 1998
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DOI: 10.1080/15140326.1998.12040520

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