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?.-
