Friday, January 28, 2011

Central Bank Intervention:Another symptom of the Chilean economy disease?(II)

It has been well known the case of an economy which has a positive price shock on its main export good, and later it has not tool to deal with its implications: It is known as ” The Dutch disease”. Chile, might have a similar problem with its leading exports good : Copper .So far, and as expected , the impact on the local currency has been an appreciation to drive it somewhat below its long run trend, within the overvalued range,creating room for Central Bank intervention on the basis of protecting welfare levels.(the gains from consumers, do not compensate the loses of exporters).-
Having said that, the issue becomes more complicated because at the beginning of the year 2000,it was set the goal for the Chilean economy, to become a developed country ending that decade, taking as a reference to set the target the Portugal economy. The target was to move from a middle income range (roughly USS 14000 p/capita), up to U$$ 24000 in the year 2010.
That goal was not possible to get. Productivity level did not increase, and it decreased specially in the last five years,(2005-2009), unemployment could not go down below 8,5% on average, inflation went out of course in 2007-2008(6%) which forced a more restrictive monetary policy , and GDP start to decrease from 6% (annual rate ) in 2004 down to -1,5% in 2008. This latest decrease, mainly due to the Global Financial crisis. Poverty increased from 13% up to 15%(roughly), in the years 2009-2010.
Thus, Chilean economy seems to have a second disease as well. This one related to the Malaysia economy , which deal with the constraints arising along the way , to move up from middle income to higher income levels status, keeping the economy in a sort of middle income trap (, January 12,2011 newsletter).In the Chilean economy case, it applies as far it was unable to become less dependent from copper exports, building up a more diversified export basket with industrial goods on the rise, to get away from the risk of too much export concentrated on raw materials, which have high price volatility. .
This second disease, was already present when copper prices start to rise at a stronger pace in recent years, and it has made more difficult to overcome the impact of such a shock. Thus, “The Chilean economy disease” means two symptoms (a).the middle income trap,(b) the loses of competitiveness on its exports due to currency appreciation.
What about the cure of this disease?. Paradoxically ,the solution goes beyond the traditional and already implemented microeconomics reforms. It includes decentralization , a long run strategic focus for public resources allocations, taking into account local government needs ,regional economies potential and better quality in services. It is needed a forward looking political reforms, an outward expansion of opportunities for citizens to take action about what they consider to be the key issue for their community . The reforms made in 2005 were inward looking, past based reforms unable to inspire collective mood . Recent polls ,show that Chilean people do not believe neither politics nor politicians who are protected in their close and narrow view of what the country need. The Chilean economy disease is mainly a political one.It is necessary to fit politics with economics.

Friday, January 14, 2011

Chilean Central Bank Intervention : Another symptom of the Chilean economy disease? (I)

These days ,there is an ongoing discussion in Chile about two issues with important implication for the midterm prospect for Chilean economy economic growth.
a.- The justification for Central Bank intervention on the foreign exchange market
b.- The question concerning the “Chilean disease” , which deals with the impact on domestic economy, of the high price for copper in world markets.
Let focus where the issue stand in both cases
a,. As it is well known, a floating exchange rate policy, has distributive implications which are not neutral, arising what it is called “the fear of floating”. A overvalue exchange rate, hurts exporters because it decrease their competitiveness as foreign price of export increases. At the same time, such overvalued exchange rate, support imports increases, lower domestic prices due lo lower price of imported input, therefore consumer get the benefit from it . It follows, that as the exchange rate fluctuates, there are winners and losers. This is when arises Central Bank role, because in such a situation, there is an higher probability of intervention throughout purchasing of foreign currency . How that this intervention happen ,if there was a compromise with free floating?. There are a couple of reasons beyond the distributive issue, which might justify by itself such intervention:
a.1. The current exchange rate ,is out of its long run flotation base line. This was the case in the recent decision of programmed intervention made by Chilean Central Bank to be applied throughout 2011, for buying U$$12000 million.
a.2. The main target to keep in mind by Central Banks authorities with their policies, is to minimize the community welfare loses due to both output and inflation fluctuations. In this case, the critical point to justify intervention , arises when the magnitude of gains made by consumers, do not compensate the magnitude of loses made by exporters , such that there is a net loses of welfare. A different issue is whether this welfare loses spread throughout a long period of time, or it concentrates in a short period, or whether is transitory or permanent. Another issue ,deals with the link between welfares loses and the degree of deviation of current exchange from its long run trend. Which is more important?. In the Chilean case apparently, both happened at the same time.
Taking into account this welfare changes, it allows Central Bank to claim that it decides beyond any fear of floating .More so, because floating exchange rate might have negative welfare implication, it applies in such a case to have an alert Central Bank to make the decision at the proper time, which it does not imply another symptom of the Chilean disease. So, let focus about this “Chilean disease”.
b.- It is widely known in the economic literature the so called “Dutch disease” ,which make the case of a country which has to deal with an huge increase in the foreign currency flows due to a sudden increase in key export prices . The mid term trend is to over appreciate the local currency, hurting exporters and decreasing economic growth expectations. Thus, what it should be positive (a better price for a key export good), become a problem due to its economic implication.-
Chilean cooper exports have increased its share from(roughly) a 36% in 1996 ,to 53% in 2010, mainly because its price rose from U$$1 in 2003 to U$$ 4 in the year 2010!.Thus, after 30 years of export lead economic growth, cooper share stay not that far the share it had in the seventies (70%).Secondly, the increase of foreign exchange flows set permanent pressure on local currency which moves it into the appreciation territory. How to cope with it to avoid the Chilean Disease?.-