Capital Account Liberalization and the Real Exchange Rate in Chile

IMF Working Papers, June 1, 2005

Source details

Canonical URL: Capital Account Liberalization and the Real Exchange Rate in Chile

After the failure of the early 1980s, a second attempt at capital account liberalization was gradually carried out in Chile during the 1990s, this time in parallel with increased exchange rate flexibility.
Capital account regulations were applied to support the independent monetary policy committed to the inflation target, while the exchange rate was quasi-pegged within a band that targeted the real exchange rate (RER).
The policy framework directed at stabilizing the RER appears to have been of limited effectiveness, with the surges and sudden-stops in capital flows playing an important role in RER dynamics.
Foreign exchange market intervention appears not to have affected the RER while reserve requirement appears to have exerted a depreciating effect.
Government spending and import tariffs appear to be significant tools to moderate the real appreciation, providing one additional reason for adopting a countercyclical fiscal policy and accelerating trade openness.

Maintain capital account regulations to support independent monetary policy committed to the inflation target in the presence of exchange rate flexibility.
Recognize that exchange rate quasi-pegging within a band targeting the RER may have limited effectiveness in insulating the RER from capital flow volatility.
Reassess the role and effectiveness of foreign exchange market intervention, given evidence it did not affect the RER in this context.
Consider the use of reserve requirements as a tool that may exert a depreciating effect on the RER.
Use government spending and import tariffs as policy levers to moderate real appreciation, supporting a case for countercyclical fiscal policy and accelerated trade openness.