The Chilean economy has made a rapid recovery from the recession caused by the Covid-19 pandemic, far exceeding expectations. This recovery has been made possible by the adaptive capacity of businesses and individuals and the breakthrough in the vaccination process, which has allowed for a significant process of openness. All of this was underpinned by the largest deployment of policy measures ever known in Chile in the face of an exogenous shock, as well as by an international environment marked by simultaneous action to contain the crisis, spearheaded by the central banks and other authorities of the world’s largest economies.

However, the extension and persistence of some local measures, coupled with households’ high propensity to consume the resources received, has had an impact on private spending that has surpassed everyone’s forecasts. In a context in which supply has yet to fully recover, this has significantly changed our assessment of the pressures facing the economy, reflected in an increase in inflation and its near-term outlook. The depreciation of the peso has also contributed, partly due to the perception of a worsening of the economy’s fundamentals resulting from the liquidation of long-term savings through successive massive withdrawals of pension savings and the deterioration of the fiscal accounts, all in a climate of high local uncertainty. Thus, interest rates, risk premiums and the stock market’s performances look poor when compared to their external similes.

The need to avoid the accumulation of macroeconomic imbalances which, among other consequences, could lead to a more persistent increase in inflation beyond the two-year 3% target, has led the Board to alter the monetary policy stance. The rapid evolution of the macroeconomic scenario, inflation expectations and sensitivity scenarios associated with greater pressures on prices, configure a scenario where the Central Bank has to act promptly to ensure inflationary convergence. For this reason, at its August meeting the Board raised the MPR by 75 basis points (bp) to 1,5% after having raised it by 25 basis points in July. It also estimates that for inflation to converge to the target it will need to continue to withdraw the monetary impulse, bringing the MPR at levels similar to its neutral towards the middle of the first semester of 2022. From there onwards the evolution of the MPR will depend on the occurrence of the sensibility scenarios described by the interest rate corridor.

Chile’s economic activity exceeded its level of before the outburst of the social crisis. In the second quarter of 2021, GDP posted annual growth of 18.1%, an achievement that combined the adaptation capacity of economic agents to the pandemic context, the impact of household income-support policies, and a very low comparison base. This trend was confirmed with July’s Imacec, which posted y-o-y growth of 18,1%, and a seasonally-adjusted monthly expansion of 1,4%.

Data for the second and early third quarters are showing an increase in consumption dynamism that exceeds June’s expectations, suggesting that the household-support policies are having a greater impact than expected. The behavior of durable consumption stands out, with a 130% annual increase in
 

the second quarter, to a level nearly 50% higher compared with the same quarter of 2019. Third-quarter data available also show that this dynamism has continued. As of July, retail sales reported by the INE —including car sales— rose 68% annually. Consumption of non-durable goods and services saw a somewhat more moderate growth —between 20% and 30% annually—, with the latter still affected by the pandemic-related supply constraints, but which, for the same reason, could respond more strongly to the advancements in the Step- by-Step Plan in the coming months.

In line with the further opening of the economy, published vacancies, employment and labor participation have been gradually increasing, although gaps affecting mostly informal employment and women persist. Survey and administrative data show a significant recovery in formal salaried employment, though with differences across sectors. This is consistent with the evolution of job vacancies, which have increased significantly in recent months. In any case, the increase in available jobs has met with a still contained labor supply, affected by the application of quarantines and state aid, as well as by the departure of hundreds of thousands of women from the labor market due to family responsibilities. The evolution of salaries is consistent with increasing labor shortage. The less formal employment categories—including self-employment— continue to lag, although incoming data point to an improvement that is consistent with the easing of mobility constraints.

The recovery of investment is strongly associated with its machinery and equipment component, which is highly concentrated in imported goods. In the second quarter, gross fixed capital formation grew by almost 25% annually, with an increase in the machinery and equipment component of almost 50% annually. The favorable performance of projects related to renewable energies and the very low comparison base contributed to this result, as did the renewal of different types of machinery and equipment in a context of accelerating activity. Meanwhile, the construction and other works component showed lower growth —13,1% annually—, with levels persistently below pre-pandemic ones.

The increase in tradable goods spending —especially in durable consumption and machinery and equipment— was reflected in higher imports and in a new negative balance of the current account. During the second quarter, volume imports of goods was up 44% annually —90% of consumer goods— reflecting growth in spending and a low comparison base. Volume exports, meanwhile, dropped by slightly more than 3% in the same period.

The strong dynamism of consumption, in a context where supply has not yet fully recovered, has put upward pressure on inflation. Data for the past few months have shown a significant increase in the prices of various products, especially in areas where demand has grown strongly, such as clothing and footwear, electronics, appliances, and automobiles. All of this in a scenario in which the restrictions on global trade chains imposed by the pandemic are still present. In fact, stock availability, shipping times and transportation costs are factors that continue to affect the performance of several industries around the world, Chile being no exception.

The cumulative massive pension fund withdrawals and fiscal transfers have increased households’ liquidity considerably. Despite the strong dynamism shown by consumption —including a significant upward surprise in recent months—, financial system data show that household liquidity continues to be high. Thus, by the end of July, the cumulative balance in personal checking and demand savings accounts was around US$23 billion higher than in July 2020. This amount is quite larger than the funds accumulated in term savings accounts and account 2 of the AFPs during that period (US$9 billion), suggesting that spending will remain dynamic in the coming quarters.

With the extension of the universal emergency family income (IFE) and the implementation of the workers’ IFE and other programs, fiscal spending growth will surpass the forecast in the June Report. Background data in the latest Public Finance Report and government announcements yield an estimate of nominal fiscal spending growth this year of more than 35% annually, with an effective deficit of more than 7% of GDP. The stronger economic growth is insufficient to finance this greater spending, thus increasing fiscal financing needs. Therefore, the authority has had to issue new Treasury bonds and once again withdraw resources from the sovereign funds.

The sell-out of long-term savings following successive massive withdrawals of pension savings, the deterioration of the fiscal accounts and the challenge of putting them back on a sustainable path, in an environment of local uncertainty, have led to an adverse evolution of local financial variables. The domestic financial market has decoupled from global movements, a situation that has been particularly visible since the beginning of the second quarter. Since then, long term interest rates have risen around 135 basis points (bp), sovereign risk has risen close to 10bp, the stock market has fallen nearly 11% and the peso has depreciated 10%. This has occurred in a context in which, after the peak of the pandemic, the indicators that measure uncertainty have not declined with the same speed as in other economies and remain above their levels prior to the onset of the social crisis.

In this context, the Chilean peso has become one of the currencies that have weakened the most in recent months around the world. This is in sharp contrast with the fact that episodes of higher economic growth and high copper prices have typically been associated with an appreciation of the currency.

Central scenario projections

The central scenario assumes that, after growing between 10.5% and 11.5% this year, the economy will slow significantly, to grow between 1.5% and 2.5% in 2022, and between 1% and 2% in 2023. The forecast growth range for this year increases in response to higher-than-expected actual data in the second quarter and a significant upward revision to the consumption trajectory. Although greater spending is also anticipated for next year, the higher comparison base results in a lower estimated growth range for 2022. By 2023, the fading effects of fiscal and monetary policy action reduce the estimated growth range for 2023. In this scenario, the activity gap is estimated to be already closed because of the greater dynamism of demand, becoming significantly positive during the second part of the year and for a good part of 2022. By 2023, the gap will return to equilibrium.

The upward revision of private consumption is the main factor explaining the revision to 2021 growth. Second-quarter data showed an increase in private spending that exceeded the June forecast, thus raising the baseline for the projections. In addition, this spending behavior, together with marginal data, showed that the portion of available resources being consumed —i.e., regular earnings, IFE and pension withdrawals— was significantly bigger than expected in June, which led to revisit this assumption. In addition, the projection incorporates the fact that the resources available for household consumption will be greater, given the announced increase in fiscal transfers —extension of the universal IFE and the workers’ IFE.

Towards 2022 and 2023, consistent with the economy leaving behind the effects of the pandemic and where the momentum from economic policies eases —among other reasons by the extinction of massive fiscal transfers—, consumption growth will decelerate. The central scenario assumes that, after reaching figures in the order of 20% on average in the second part of 2021, the annual variation of private consumption will fall to an average of around 0,5% in the 2022-2023 period. This result combines the very high comparison base, the extinction of the universal IFE, the depletion of the liquidity accumulated by pension fund withdrawals and the tighter financial conditions.

As for investment, the central scenario foresees that, after growing nearly 16% annually this year, several restrictive factors will surface that will tone down its expansion to 0.3 in 2022 and 0.6% in 2023. In this case, in addition to the challenging comparison base of 2021, there is the persistently slow emergence of new large-scale projects—with the exception of renewable-energy projects—, the significant rise in long-term interest rates, the impact of the peso depreciation, the stock market downturn and the still high uncertainty by historical comparison. The expected behavior of investment in Chile differs from what is expected in other economies, where the post-pandemic recovery is showing a much greater traction of this component of domestic demand.

The central scenario assumes that fiscal policy will enter a path of convergence toward expenditure and deficit figures in line with the structural balance rule, consistent with the Public Finances Report and the recommendations of the Autonomous Fiscal Council. Any deviations from this path will be particularly relevant for monetary policy, not only because of the impact that fiscal policy has on private spending, but also because of its implications for financial market variables, particularly the evolution of long-term interest rates and the exchange rate.

Short-term inflation projections are revised upward significantly because of the strong dynamism of consumption, the idiosyncratic depreciation of the peso, the higher fuel prices, and global and domestic supply still unable to recover completely. In the central scenario, annual CPI inflation will close the year at 5.7% (4.4% in June), to remain above 5% during the first half of 2022 explained also by rises in the volatile component of energy and food prices. Core inflation (i.e., the CPI minus volatiles) is also revised upward from June, to an estimated 4.7% by year’s end and peaking towards mid–2022, where its annual change will approach 5.5%.

The idiosyncratic nature of the peso depreciation means a higher pass-through to inflation. In recent months, the peso has lost value with respect to both the dollar and multilateral currency baskets. Thus, comparing the statistical cut-offs of this and the June Reports, the peso/dollar parity has risen around 8%, a figure that falls only slightly when considering the levels of the multilateral exchange rate (MER). In real terms, the peso has also depreciated significantly, with the RER having increased more than 10% this year to date. As has been documented on earlier occasions (see Box IV.1, MPR March 2018), the size of the average pass-through coefficient from the nominal exchange rate to inflation is higher when the parity moves because the economy is hit by an idiosyncratic shock like the present one, as opposed to a shock associated with global factors. As a reference, the estimates show that a 10% increase in the nominal exchange rate is associated, one year later, to an increase in inflation of the order of 2.5% when it responds to an idiosyncratic shock, and 0.5% when it responds to a global shock.

The slowdown in demand resulting from the withdrawal of fiscal and monetary stimulus policies, among other things, will bring inflation to converge to 3% in the two-year policy horizon. Thus, after peaking between the end of this year and the turn of 2022, the CPI’s annual variation will begin to drop to less than 4% at the end of 2022 and close to 3% at the end of 2023.

The external scenario backing this forecast is hardly unchanged compared to June and assumes that the world economy continues to leave the effects of the pandemic behind and that the copper prices converge slowly to its long-term level. On aggregate, global economic data have shown no major surprises in recent months, which is consistent with world growth projects that, despite some changes in composition, show no big variations either. This does not overlook the fact that pandemic issues —infections, variants, and vaccinations, among others— will continue to impact on short-term figures and, especially, on the behavior of financial markets. The prices of commodities, with some exceptions, have declined in recent months. Actually, consistent with June projections, the copper price moved away from its record-highs of mid–May and is now closer to US$4.2 per pound.

Sensitivity scenarios

The central scenario is based on a set of assumptions about the economic environment, the behavior of agents, and policy stances. Based on those assumptions, sensitivity tests are performed which, keeping GDP growth around the projected ranges, call for a somewhat different monetary policy. These scenarios form the MPR corridor presented in chapter V (figure 1).

On the external front, the strong recovery and cost pressures may lead to higher-than-expected inflation in developed economies, requiring an earlier increase in their interest rates. Such a scenario would hurt the financial conditions of emerging economies, including a depreciation of their currencies, and
would reduce global growth. In such a situation, there are countervailing forces at work on activity and prices, so the reaction of the MPR will depend on which of these dominates. However, given the current lower room for maneuver, it cannot be ruled out that the MPR should be above what is considered in the central projection scenario.

Locally, there are scenarios where the future evolution of consumption could yield the way to trajectories pulling the MPR in opposite directions but within the bounds of the corridor. On the one hand, it is possible that the propensity to consume the resources from government transfers and withdrawn pension savings will be even greater, which would further boost consumption. Such a scenario would require a more contractionary monetary policy response to converge to the inflation target, placing the MPR trajectory above that defined in the central scenario. On the other hand, a scenario in which consumption is less dynamic than expected could also occur, either because its current dynamism reflects an anticipation of spending decisions or because environmental factors, such as a worsening of the pandemic, lead households to hold back. Such a scenario would reduce inflationary pressures in the short term, allowing monetary normalization to proceed at a slower pace.

The upper bound of the corridor is defined by a scenario where lower uncertainty results in lower inflationary pressures. Such a situation could occur if uncertainty regarding the continuation of massive pension fund withdrawals and the ability of fiscal policy to return to a credible path of convergence were to recede. This would have an impact on financial conditions and the path of consumption, giving monetary policy more room for maneuver. This would allow for a significantly slower normalization of the monetary impulse.

The upper bound of the corridor is defined by a scenario where the start of fiscal consolidation is delayed. Such a situation could have significant effects on the economy, requiring an even stronger monetary policy reaction to adjust macroeconomic imbalances. In such a scenario, higher inflationary pressures would lead to the need for a more accelerated increase in the MPR.

Risk scenarios

In addition to the sensitivity exercises, risk scenarios are analyzed in which the changes in the economy would be more significant and where the monetary policy reaction would surpass the limits of the MPR corridor.

As in the June Report, one of the risks identified is one where the evolution of public finances may not be clear about their long-term stabilization. In this case, it would be possible to see not only greater spending pressures than those foreseen in the central scenario, but also their amplified impacts on the financial market. In such a situation, higher inflationary pressures would lead to the need for a more accelerated increase in the MPR, despite which inflation would fail to converge to the policy target within the two-year horizon.

Another risk scenario is one where the persistent discussion regarding the stability of pension fund savings ends up significantly altering the functioning of financial markets. Originally, this measure was conceived as a one-off, exceptional measure, amid an economic emergency. However, new withdrawals have been approved and proposed, which have had significant effects on the economy as can already be seen in the behavior of long term interest rates and the exchange rate. It is highly likely that additional withdrawals, or even the possibility of a 100% withdrawal, can lead economic agents to consider that there is a structural change in the savings base of the economy —which has been key for the development of the country—, the dynamics of investment and fiscal access to financing at an adequate cost. A change in this direction would cause multiple negative effects hard to quantify, but surely big and persistent.

In the more immediate future, a new withdrawal will increase the liquidity of households, boosting an already dynamic consumption, and putting an even higher pressure on prices and on the inflation path. Added to this is the fact that keeping the discussion regarding this issue open is already significantly increasing financing costs, generating flight of capital and an accumulation of dollar-denominated funds. All
these phenomena would be significantly amplified by the approval of a new withdrawal that generates mistrust regarding the fundamental structures that sustain the financial market. No central bank has the powers, instruments or resources to neutralize risks of this magnitude and restore macroeconomic equilibrium.

Although for now this is a risk scenario, its probability of occurrence may be already affecting economic agents’ behavior. Unlike what happened during the discussion of the previous withdrawals, since the discussion of a fourth one was announced, the exchange rate has depreciated significantly. This has occurred even considering the substantial volume of dollars that would enter the country due to the liquidation of the AFPs’ foreign portfolios, which should occur if this measure is approved.

Monetary policy orientation

The economy has already overcome the immediate impacts of the pandemic on activity, and it is necessary for public policies to adapt to prevent imbalances between production and expenditure from persisting over time and becoming a costly burden on the country. GDP has already returned to the levels prior to the social crisis outbreak, reflecting the significant efforts of individuals and businesses, which have been supported by a set of measures in which monetary policy has played a major role (box V.1). Nonetheless, the magnitude of demand stimulus policies has led consumption to be much more dynamic than other components of private spending. Sustaining this kind of growth would be very detrimental, particularly because it would not help to reduce the gaps that still exist in the labor market.

Monetary policy will strive to avoid macroeconomic imbalances that are harmful for people’s well-being. It is important to bear in mind that inflation is particularly detrimental to middle- and low-income households, which lack the mechanisms to protect their purchasing power and assets that are available to the better-off.

Our short-term projections point to inflation standing above 5% in the next few months and longer- term expectations have been rising. The importance of keeping inflation expectations anchored to the Central Bank’s target and avoiding a costly further deterioration for the economy is evident. A scenario in which this does not occur would require drastic monetary policy responses. The Central Bank will act in accordance with its mandate to control inflation, a task that will be less costly for the economy insofar as other players contribute to restoring the macroeconomic balances that have been lost during the pandemic.

In the central scenario, the Board estimates that for inflation to converge to the target it will need to continue to withdraw the monetary impulse, bringing the MPR at levels similar to its neutral towards the middle of the first semester of 2022. From there onwards the evolution of the MPR will depend on the occurrence of the sensibility scenarios described by the interest rate corridor. It is the Board’s view that sensitivity scenarios associated with higher price pressures have a somewhat higher probability of occurrence, which could lead to an MPR path closer to the upper bound of the interest rate corridor. As always, the conduct of monetary policy will be contingent on the effects of new information on the projected dynamics of inflation.