Download Policy Responses to Sudden Stops in Capital Flows

Policy Responses to Sudden Stops
in Capital Flows:
The Case of Chile in 1998
Rodrigo Valdés
Central Bank of Chile
Motivation: Why Chile 1998?
• Chile confronted a large “sudden stop”:
– Net capital inflows were equivalent to 7% of GDP in the year
ending in 98Q1 and dropped to less than 1% of GDP in
99Q1.
• In comparison to other episodes, with financial sector
meltdown and a deep recession, this case could be considered
a successful one: mild recession.
• In many Chileans’ minds, strong doubts remain on the
efficiency of the adjustment.
2
The paper:
•
Revisits the 1998 Chilean episode, underpinning the
following:
1. The policy framework and initial conditions;
2. Shocks;
3. Immediate policy responses and macro adjustment;
4. Subsequent overhaul of the policy framework;
5. The Chilean case in perspective;
6. Some lessons
3
1. Policy Framework and Initial
Conditions
Macro policy framework-key components
before the episode:
• An independent CB in transition to price stability:
– Annual inflation targets;
– XR target band with PPP adjustments;
– Capital account regulations.
• Orderly managed fiscal policy:
– Public debt declined from 38% of GDP in 1989 to 5% in 1997;
– Most of external debt was private.
• Strong financial institutions
– Well regulated and supervised banks.
5
Cyclical conditions in 1997:
• Against a backdrop of very strong GDP growth (7.7% in 19901997), signs of overheating in 1996-97 included:
– Current account deficit above 4% of GDP;
– Marked FX appreciation, with signs of misalignment, despite
heavy intervention;
– Increasing core inflation in 1996.
• The economy’s overheating was a public policy issue:
– Special commission to design ways to foster savings;
– Strong discussion on role of fiscal policy (surplus 2% in 97);
– Extra provisions for consumer credit.
6
2. Shocks
In late 1997, ToT dropped suddenly and
threatened to increase the CA deficit…
Unit Price of Exports in US Dollars in Real Time 1997Q2-1999Q2
(% annual change)
5
As of May 15 1998
As of Aug 15 1998
As of Nov 15 1998
As of Today
As of Feb 15 1999
0
1997Q2
1997Q3
1997Q4
1998Q1
1998Q2
1998Q3
1998Q4
1999Q1
1999Q2
-5
-10
-15
-20
8
…while domestic demand remained strong
and fiscal accounts weakened.
Current Account Deficit in Real Time
(cumulative four quarters, US$ million)
As of Feb 15 1998
As of Nov 15 1998
Final
As of May 15 1998
As of Feb 15 1999
As of Aug 15 1998
As of May 15 1999
1000
0
1997Q3 1997Q4 1998Q1 1998Q2 1998Q3 1998Q4 1999Q1 1999Q2 1999Q3 1999Q4
-1000
-2000
-3000
-4000
-5000
-6000
-7000
9
External financing was expensive, but
gross outflows dominated dynamics.
Changes in Gross Assets and Liabilities (Transactions)
(cumulative four quarters US$ millions)
15,000
Liabilities
10,000
5,000
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Assets
-5,000
-10,000
-15,000
Assets Ex International
Reserves
10
3. Immediate policy responses:
Restrictions and effects
Policy objectives and restrictions:
• Central objective: cool down the economy:
– Diagnosis: It would happen anyway, either through domestic
policy or market-induced.
– Market induced more costly (fear of “sudden stop”).
• Restrictions:
– Limit nominal depreciation:
• Short-term inflation target and imperfect credibility;
• Large perceived XR pass-trough;
• Fear of balance sheet effects due to perceived
mismatches.
– Political constraints to implement fiscal policy.
12
Non sterilized FX intervention and tight
monetary policy…
Monetary Policy and Interbank Overnight Interest Rate in 1998
(% + UF)
60
Fiscal Adjustment
Announcements:
50
Jan. 19th
Mar. 21st
40
Jun. 25th
30
20
10
0
Jan
Fe
Ma
Apr
Ma
Jun
Jul
Au
Se
Oc
No
De
13
“Commitment technology” increased
rigidities and vulnerability.
Exchange Rate Target Band 1997-1999
(pesos per US dollar)
560
540
520
500
480
460
440
420
D
O
S
J
J
A
M
1999
D
O
S
J
J
A
F
1998
N
O
A
J
M
A
F
1997
400
14
CA Adjustment: absorption contracted
strongly with little demand switching…
• RER depreciated only in late 1999;
• Share of tradable goods stable in value added;
• Stable contribution of exports to GDP growth.
Domestic Demand and Exports’ Contributions to
GDP Growth (%)
Tradable Goods Participation in Value Added (%)
20%
10
18%
8
16%
6
14%
4
12%
2
10%
-4
2000,2
2000,1
1999,4
1999,3
1999,2
1999,1
1998,4
1998,3
1998,2
1998,1
1997,4
1997,3
1997,2
-2
1997,1
0
8%
6%
4%
-6
2%
-8
Net Domestic Demand
Exports
0%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Agriculture
Fisheries
Mining
Manufacturing
15
Policy effects and adjustment.
•
Financial market calmed down after CB policy actions.
•
Fiscal policy announcements had no evident effect on financial
markets. Real- time “opinions” were mixed/negative.
•
Credit followed a very pro-cyclical pattern. Banks’ indicators
deteriorated, but remained in OK zone.
•
Capital outflows in early 1999 driven by pension system (made
possible by change in foreign investment limits).
•
Large turnaround of macro policies in 1999, particularly fiscal.
16
4. Subsequent overhaul of the
policy framework
Results led to deep changes in the macro policy
framework in 1999-2001…
• XR floating regime;
• Deepening of XR hedging market;
• Full fledged inflation targeting;
• Fiscal policy rule based on structural target;
• Capital account liberalization;
• Nominalization of monetary policy;
… which combined with a different cyclical position
implied a very different policy mix after 2001-2002
shocks.
18
5. The Chilean case in perspective
Among Sudden Stop episodes, Chile’s intensity
is around average...
Distribution of Shock Severity as % of Trade
(kernel, 55 cases)
6
5
4
3
2
1
Chile 1998
Perc. = 40
0
-.6
-.5
-.4
-.3
-.2
-.1
.0
20
…but the policy response and outcome stand
out in a few dimensions:
• Fairly good inflation performance;
• Average growth outcome;
• Not very intensive in FX reserve intervention;
• Rather mild RER depreciation;
• Rather high real interest rates.
21
6. Some Lessons
Among other things, the Chilean case
shows the following:
• Financial system resilience and public finance (ex-ante) seem
key to avoid meltdown and give room for aggressive macro
management.
• With hindsight adjustment could have been more efficient
(more RER less AD)
– Some priors proved unfounded: low pass-through, low
currency mismatches.
– Other priors yet “untested”: (costly) market induced
adjustment
• Policy framework too rigid: annual inflation target, XR band…
23
Among other things, the Chilean case
shows the following:
• Potentially large costs of interest rate spikes (liquidity
crunches).
• Implementing “macho” credibility can be self-defeating
(Europe ’92).
• Private sector AD responds to fundamentals.
• Although the counterfactuals are unknown, fiscal policy
announcements apparently did not buy much credibility.
• Outflows were a key element behind the story limiting
applicability to other EMEs.
24
Policy Responses to Sudden Stops
in Capital Flows:
The Case of Chile in 1998
Rodrigo Valdés
Central Bank of Chile
…but relatively stronger drop in importintensive demand components.
Contributions to Domestic Demand Growth
(%)
15
12
9
6
3
2000,2
2000,1
1999,4
1999,3
1999,2
1999,1
1998,4
1998,3
1998,2
1998,1
1997,4
1997,3
1997,2
-3
1997,1
0
-6
-9
-12
Durable consumption (5.1%)
M&E (9.9%)
Construction (16,0%)
Rest (69.0%)
26
Major drop in GDP growth was largely
unexpected (as was CA adjustment…)
10
Expected and Actual GDP Growth
(cumulative four quarters, % annual change)
8
6
4
2
0
1998Q1
1998Q2
1998Q3
1998Q4
1999Q1
1999Q2
1999Q3
1999Q4
-2
-4
1999 CB and MoF Forecast
1999 Consensus
Actual Base 1986
Actual Base 1996
27