The economic recovery has been a positive surprise during the first months of 2021, reflecting the strong macroeconomic momentum and the agents’ better adaptation to the sanitary constraints. Private consumption has risen strongly, fueled by pension savings withdrawals and massive fiscal transfers. Added to this are the recently approved reforms so that fiscal expansion will significantly exceed the March forecast. The better recent performance combined with the increased spending impulse, in a context of more favorable external conditions, lead to a significant correction in this year’s projected growth. Even with these advances and more positive prospects for recovery, the general perception remains marked by the evolution of infections and quarantines, the significant backwardness of some sectors, the fragilities in the labor market and the persistence of high uncertainty. The local financial market has reacted to these developments, and long rates have risen while their external counterparts have not, the stock market has fallen, and sovereign risk has seen a moderate increase. The higher growth rate expected for 2021 will bring the closing of the wide activity gap caused by the Covid-19 crisis forward, reducing the need for monetary impulse to support the recovery of the economy. Thus, it should begin to moderate sooner than was expected in the last MP Report. This will prevent an increase in inflation —currently around 3.5%— from raising the cost of living and eroding the purchasing power of the households most affected by the crisis. Even so, in the central scenario, the monetary policy rate (MPR) is expected to be held below its neutral level throughout the policy horizon, underpinning a recovery process that will continue to endure significant challenges.

So far in 2021, the Chilean economy has outperformed expectations, as the impact of the quarantines on activity has been notably lower than anticipated. In fact, although activity declined during March and April, the effect of the tightening of sanitary restrictions was about one-fifth of what it was at the onset of the pandemic. Several factors contributed to this result: the greater adaptation of companies to the demands of social distancing; the support of favorable financial conditions; adjustments to the Step-by-Step plan; and the boost to demand by public policies.

The withdrawal of pension savings and massive fiscal transfers have been major determinants of the dynamism of private consumption, which has steered the economic rebound. In the first quarter, private consumption rose by almost 5% annually, with a nearly 50% increase in spending on durable goods, most notably for the purchase of technological items and automobiles. Information from the retail trade, supermarket sales and digital billing shows that the consumption of goods continued to be dynamic during April and May. Spending on services, meanwhile, despite having recovered part of last year’s decline, continues to show negative annual variation rates, reflecting the persistence of supply-side constraints.

In the first quarter, gross fixed capital formation posted slight annual growth driven by the recovery of the machinery and equipment component, which rose 21.5% annually. Construction and works, dropped around 10% annually, because of works being slower or postponed due to the pandemic.

The labor market continues to improve, although heterogeneously. INE data suggest that more than half of the jobs lost throughout the pandemic have been recovered. However, self-employment and informal salaried employment, low-skilled workers and women remain the most lagging segments. In fact, female participation is still far from its pre-pandemic rates, reflecting the extra household care responsibilities that many women have had to assume. On the other hand, the number of contributors to pension funds and unemployment insurance are back to pre-pandemic levels, signaling that formal salaried employment has benefitted the most from economic recovery. In turn, inactivity has declined, though still high by historic standards, and vacancies are up, resulting in the unemployment rate being still near 10%. In addition, the extension of quarantines hit self-employment and informal salaried jobs harder, while applications to unemployment insurance have also risen, even though they are not as high as their 2020 levels. All of this is indicative that the recovery of the labor market is still fragile and uncomplete.

Since the last MP Report benefits for households and small firms have been extended, and the recently approved measures will extend them further. In the second half of April, the Administration announced the reinforcement of the middle-class bonus and the Emergency Family Income, together with a complementary bonus for those having no funds available in their retirement accounts. Congress approved a third withdrawal of pension savings, which includes an “advance of benefits” for pensioners with life annuities. In addition, in the context of the Common Minimums Agenda, substantial extension and expansion of transfers has just been approved, including an extension of both amounts and coverage of the Emergency Family Income, reaching more than 15 million people over the next four months, subsidies and tax benefits for micro and small businesses are being discussed as well.

On aggregate, these initiatives will lead fiscal spending to grow by around 25% nominal in 2021, which compares to the 5% considered in the March Report. This will lead to a significant overshoot of the structural deficit planned for the year, which the Government would formalize by invoking an “escape clause” from the committed fiscal objectives. Although new official projections are not yet available, it seems clear that, despite the improved outlook for activity, this year’s fiscal impulse will not only exceed projections, but will be significantly higher than it was in 2020.

Despite the recovery of activity and the extension of fiscal stimulus measures, the overall economic perception deteriorated in the last few months, with consumers’ expectations still in pessimistic territory. This could be explained by such factors as the evolution of infections, the quarantines and the heterogeneity that is observed in the recovery. Regarding the latter, it should be noted that the performance of some services, construction and human transportation has yet to reach its pre-pandemic levels, a milestone that trade and manufacturing achieved six months ago or more. There is also the aforementioned heterogeneity in the labor market.

Business expectations show differences, with stronger effects on smaller firms and sectors lagging farther behind in their recovery. The May Business Perception Report (IPN) showed that the smallest businesses were hit harder by the quarantines of March and April. Moreover, this Report noted that a non-negligible fraction of firms was having second thoughts about their investment projects for this year or had simply cancelled them.

In this context, uncertainty indicators are still high, well above its levels prior to the social outbreak, and the local financial market has decoupled itself from global trends. Thus, long-term interest rates have risen 30 basis points (bp) since mid-April to date (BCP10), while their external benchmarks have not changed much. This has been accompanied by a stock market drop of just over 10%, a 2% peso depreciation and an increase in the sovereign premium (CDS) of 15 bp, despite the significant rise in the copper price. This has coincided with a period of heightened political tensions and a wide range of legislative initiatives in social security, fiscal and regulatory matters.

On the external front, world growth has been gradually consolidating the favorable outlook for this and next year, which has been internalized by the global financial markets. The evolution of the external scenario is closely linked to the progress of vaccinations and reopenings in developed economies, which has resulted in a rebound and strengthening of consumer and business confidence and activity in the most lagging sectors. Global financial markets have picked up on this scenario, encouraging greater risk-taking, higher stock prices and widespread appreciation of asset prices. As a result, financial conditions have remained favorable, owing particularly to the greater stability of long-term rates, the decline in corporate spreads and risk premiums, and capital inflows to emerging markets. However, this picture is not common to all economies, with significant lags in those where controlling the pandemic is still a complex task, where there is no significant vaccination plan in the short term, where policy space is limited and/or where domestic tensions have increased. This is currently the case in several Latin American countries.

International food and commodity prices have also been boosted by the prospect of global recovery, which combine with supply-side difficulties and a depreciated dollar. Copper hit a record-high price of US$4.86 per pound in early May, and at the statistical close of this Report was hovering around US$4.50, an 11% rise over March. The price of oil has also risen, and today it stands above US$65 per barrel.

The above, together with higher transport prices, has fueled the cost pressures that are facing businesses around the world. In fact, the cost of maritime freights has tripled, while the prices of other inputs and staples such as building materials, foodstuffs, and agricultural crops have also seen considerable hikes. It has all reflected in higher producer prices and short-term inflation expectations in various economies.

Although the global markets estimate that the effects on inflation in various countries will be mainly temporary, there is increased concern in those economies where demand-boosting measures have been more substantial. In the United States, inflation was unexpectedly high in March and April, while a large fiscal aid package and a still highly expansionary monetary policy are being implemented. Measures of inflation expectations have risen, while financial markets have experienced bouts of volatility associated with that variable.

In Chile, inflation has performed as expected, with annual CPI variation rising to 3.6%. Expectations are aligned with the two-year target. The annual variation of the CPI has continued to be largely determined by the evolution of the prices of goods and energy. The former are still pressured by tight inventories in a context of high demand. The latter have been influenced by the oil price hikes and the low comparison base. The core CPI stands today at 3.4%.

Projections

The central scenario significantly raises the growth forecast for this year, to a range between 8.5 and 9.5%. Nearly two thirds of the difference with the March forecast is explained by the accumulation of expenditure-boosting policies, and the other third mainly by the better beginning of the year and agents’ adaptation. The massive fiscal transfers and the approval of the third withdrawal of pension savings lead to predict annual growth in private consumption at around 15% (around 12% in March). Meanwhile, gross fixed capital formation increases 11.4% in the year, and total exports grow somewhat more than 1%. In this scenario, the activity gap closes sooner than previously estimated.

For 2022 and 2023, growth ranges are revised downward because of the higher comparison base, the steady decrease in consumption-boosting measures, and limited investment dynamism. In the central scenario GDP rises between 2% and 3% in 2022, and between 1.75% and 2.75% in 2023. The annual increase in private consumption will moderate significantly in the next two years, largely reflecting the gradual utilization and normalization of the income-support measures. As for investment, in 2022–2023 significantly lower expansion rates are expected compared with 2021, mainly because of low dynamism of GFCF in construction and works, the slow addition of new projects into the surveys, the persistently high uncertainty, higher corporate borrowing, and the evolution of domestic financial conditions.

A core element of these forecasts is fiscal policy, which this year will add a stronger impulse than that contemplated in March, considering the announcements already materialized and the additional spending that, among others, will result from the recently approved new support measures for households. For 2022 and 2023, estimates are that the massive fiscal impulse will be withdrawn, giving way to policies focused on the most lagging segments and the stabilization of public finances. Thus, after record-high expansion in 2021, the central scenario considers that the fiscal accounts will be inserted in a path of convergence to structural targets and towards a sustainable public debt-to-GDP ratio, in line with the recommendations of the Autonomous Fiscal Council. This could be reinforced by permanent increases in tax revenues, derived from the reforms that have been recently announced by the Government.

This year, the current-account deficit will be similar to the March forecast, as the higher copper price compensates for the expansion of domestic expenditure. All in all, between 2020 and 2021 the current account balance will turn negative, reflecting the increase in domestic demand. Compared to March, during the three-year period 2021-2023, the world economy will post slightly higher growth rates and the annual average copper price will be between 20 and 30 dollar cents per pound higher. In addition to the recent rise, this correction responds to its higher long-term price. Despite the increase in the oil price over the projection horizon, the terms of trade are, on average, 4% higher than estimated in March.

The stronger impulse to consumption, in the context of an earlier closing of the activity gap and rising cost pressures, leads to a higher inflation forecast. Core inflation will close the year slightly below 4% annually. Higher energy prices will continue to dominate the volatile component. Thus, after reaching higher values in the second half of the year, in December 2021 annual headline CPI inflation will be 4.4%. In 2022 and 2023, as the fiscal and monetary impulses normalize, inflation converges towards 3%, to remain stable until the end of the policy horizon, i.e., the second quarter of 2023.

This Report revises down the economy’s medium-term growth, given the persistent drop in productivity growth over the past decade. Our estimate of non-mining trend GDP growth is lowered to the 2.4%–3.4% range for the ten-year period 2021-2030, which compares with the 3.25–3.75% range estimated for 2019-2028. This revision responds to the lower projected growth in total factor productivity1/, an assumption surrounded by a high degree of uncertainty, which is reflected in the wider range of trend growth estimates. This partly reflects the fact that the estimates do not include the potential effects —upward or downward— caused by the structural changes induced by the pandemic, or by the political/institutional process underway.

Potential GDP —which measures growth capacity over shorter terms, where full resource allocation is not achieved— is revised upward, despite the downward revision to trend growth. For the period 2021-2023 trend growth is estimated around 2.1% (around 1.7% in March). This reflects the greater adaptive capacity of the economy and the milder scars that the pandemic would be leaving, which reduces the persistence of its negative effects on factor productivity and availability. All in all, in the medium term, potential GDP should converge to figures comparable to trend.

For the neutral MPR, the bulk of estimates yields figures in the order of 0.5% in real terms. According to the range of estimates and the uncertainty around this calculation, the Board assumes that the neutral MPR is in the 3.25% to 3.75% range in nominal terms, that is, a 50 bp cut in the bounds of the estimated range until March. This partly reflects the global trend to lower neutral interest rates observed in recent years, and is consistent with the reduction in Chile’s trend growth estimate. Regarding the technical minimum for the monetary policy rate, estimations remain at 0.5%.

Summing up, the higher activity forecast for 2021 is largely explained by the increase in private consumption, responding to the accumulation of stimulus measures adopted since the last MP Report. An important part of these measures reflect a considerably more expansionary fiscal policy than previously foreseen. The outlook for investment and exports, on the other hand, is more limited, with a tendency of the former to decelerate. Accordingly, a scenario where the recovery is notoriously biased towards consumption is emerging, which, if maintained or deepened through more pro-cyclical policies, could incubate larger macroeconomic imbalances, a risk that must be duly anticipated.

Sensitivity and risk scenarios

The central scenario is based on a set of assumptions such as those described in the preceding paragraphs, which shape the forecasts in this Report. On these assumptions, sensitivity exercises can be carried out that, while keeping GDP growth in the foreseen ranges, would require a somewhat different monetary policy action. These scenarios define the MPR corridor presented in the chapter “Future evolution of monetary policy” (figure 1).

On one hand, it is possible that demand grows beyond projections, either because increased propensity of households to consume—in a context of economic de-confinement— or because of greater fiscal transfers than the ones already assumed. In the latter case, tax, liquidity, or public investment measures could be added, thus making fiscal policy even more pro-cyclical. In such a situation, higher inflationary pressures would make an earlier withdrawal of the monetary stimulus necessary, which is reflected in the upper bound of the MPR corridor.

On the other hand, investment continues to be the most lagging component of expenditure, and a worse-than-anticipated evolution cannot be ruled out. The data show that in the first quarter investment in construction and works failed to recover, that no major investment projects have entered the surveys, and that local political/legislative events have affected the stock market, typically correlated with the future evolution of investment. If this situation were to worsen to the point of stagnation or reversal of investment, the monetary policy stance would have to remain highly expansionary for longer, which is reflected in the lower bound of the MPR corridor.

Despite the significant recovery of the economy, the pandemic phenomenon is still present and unexpected things can still happen. The central scenario assumes that during the second half of the year there will be a growing de-confinement of the population and a relaxation of social distancing measures, as the goals of the vaccination process are achieved. However, new cases have risen lately, and new quarantines have been imposed in several districts. Should they intensify, a slower opening is possible, delaying the closing of the activity gap, and requiring the current monetary expansionary stance to be maintained for some more time.

Abroad, it cannot be ruled out that the cost pressures faced by firms at the global level may have longer-lasting effects on inflation. World recovery, within a context of ongoing logistical problems for production, has led to cost increases across the board. For the moment, this is expected to be a transitory phenomenon, as the gradual opening of economies and greater adaptation will normalize the supply of many goods and services. In any case, considering high domestic spending, local inflation might be somewhat higher than forecast in the short term. The temporary nature of such an event does not require a monetary policy reaction. However, a different scenario would emerge if global inflationary pressures had a more persistent impact on domestic inflation. The latter would call for an earlier withdrawal of the monetary stimulus.

Besides the sensitivity exercises, risk scenarios in which the changes in the economy would be more significant and where the monetary policy reaction should be more intense are also analyzed. Locally, the risks associated with an evolution of public finances that is unclear as to their long-term stabilization are worth noting, which could affect local financial conditions, investment, and the perception of country risk. Internationally, the main risk continues to be an abrupt change in global financial conditions, an event that has become more prevalent due to doubts about the evolution of inflation in the U.S. The intensity of these scenarios may jeopardize the convergence of inflation within the policy horizon, placing activity below the expected ranges and/or compromising the proper functioning of financial markets.

Monetary policy orientation

The better recent performance of the economy, the significant boost to domestic demand, the imbalances in the dynamics of expenditure and production, added to cost pressures, will affect the behavior of prices. Knowing how much of these effects will be temporary and how much will be more persistent will be key to determine the correct degree of expansiveness of monetary policy, so as to ensure sustainable economic recovery in an environment of price stability.

For now, the Board estimates that the economy is still affected by the impact on the recovery of the pandemic and the lagging labor market. However, the strong dynamism already present in consumption and the additional boost to private spending are an important change for the macroeconomic scenario of the coming months, which makes it necessary to recalibrate the expansiveness of monetary policy going forward.

In particular, the higher growth forecast for spending and activity will make it less necessary for the monetary impulse to support the recovery of the economy with the current intensity, so it should gradually begin to moderate, earlier than was expected in the previous MP Report. This will help to avoid the build-up of inflationary pressures at a particularly sensitive moment in the recovery. It is important to bear in mind that inflation is particularly detrimental to middle- and low-income households that do not have the purchasing power and asset protection mechanisms available to the better-off. Therefore, a scenario of higher inflation would only amplify the regressive impact of the job losses that these sectors have endured during the crisis.

However, even in a context of gradual normalization, monetary policy will continue to accompany the recovery of the economy. Thus, starting from one of the most expansive levels compared to peer economies, in the central scenario the MPR  is anticipated to remain below its neutral value throughout the two-year policy horizon.

As for unconventional policies, they have recently concluded, and no changes are foreseen in their current conditions and timing. This includes wrapping up the stage of reinvesting the bank bond coupons at maturity, letting the stock still in the Central Bank’s hands to be steadily reduced.

Beyond monetary policy conduct, the profound crisis of the last nineteen months will pose major challenges to the Chilean economy. Importantly, there is the need to shape a sustainable trajectory for public finances, reduce economic uncertainty, and reverse the reduction in trend growth described in this Report. The way these challenges are met will not only have an impact on the future evolution of monetary policy, but especially on living conditions and the country’s future prospects.