{
  "title": "Outside the Band: Depreciation and Inflation Dynamics in Chile",
  "publication": "IMF Working Papers, July 6, 2016",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059",
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  "summary": "This paper examines inflation dynamics in Chile during the last peso depreciation episode 2013-15. The evidence is for substantial pass-through effects to inflation, given the large and persistent depreciation movement.",
  "sections": [
    {
      "heading": "Summary",
      "content": "- Examines inflation dynamics in Chile during the peso depreciation episode 2013-15.\n- Evidence points to substantial exchange rate pass-through effects to inflation given the large and persistent depreciation movement.\n- Widespread indexation practices in non-traded goods markets amplify the inflation response to the depreciation; wage indexation is found to be less relevant.\n- Counterfactual: inflation would have remained within the central bank’s target band absent the peso depreciation.\n- Tightening monetary policy in response to a depreciation shock can be costly in terms of output: the response of activity to rates is strong, while the transmission from activity to inflation is weak.\n- Simulations under uncertainty about the extent of the pass-through suggest monetary policy can play a countercyclical role in the face of depreciation shocks at a moderate inflationary cost, provided inflation expectations remain anchored."
    },
    {
      "heading": "Key findings",
      "content": "- Substantial pass-through from the peso depreciation during 2013-15 to overall inflation.\n- Amplification channel: widespread indexation in non-traded goods markets increases inflation response.\n- Limited role of wage indexation for the inflation dynamics in this episode.\n- Without the depreciation, inflation would have remained inside the central bank’s target band.\n- Monetary tightening following a depreciation shock:\n  - Strong negative effect on output (activity responds strongly to interest rates).\n  - Weak effect on inflation (activity-to-inflation transmission is weak)."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- Monetary policy faces a trade-off when responding to depreciation shocks: mitigating inflationary effects can incur sizable output costs.\n- If inflation expectations remain anchored, monetary policy can act countercyclically against depreciation shocks while accepting a moderate inflationary cost.\n- Policy design should account for the amplification role of indexation in non-traded goods when assessing pass-through and the appropriate policy response."
    },
    {
      "heading": "Simulations and scenarios",
      "content": "- Simulations consider uncertainty about the extent of exchange rate pass-through.\n- Results indicate:\n  - Monetary policy can be countercyclical under moderate inflationary consequences.\n  - Anchored inflation expectations are a key condition for a successful countercyclical policy response.\n\n---\n\n Content in this bundle\n\n- Wp16129\n  - Wp16129 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Wp16129 (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059"
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    "Authors: Esther Perez Ruiz",
    "Published: July 6, 2016",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781498350976.001",
    "Examines inflation dynamics in Chile during the peso depreciation episode 2013-15.",
    "Evidence points to substantial exchange rate pass-through effects to inflation given the large and persistent depreciation movement.",
    "Widespread indexation practices in non-traded goods markets amplify the inflation response to the depreciation; wage indexation is found to be less relevant.",
    "Counterfactual: inflation would have remained within the central bank’s target band absent the peso depreciation.",
    "Tightening monetary policy in response to a depreciation shock can be costly in terms of output: the response of activity to rates is strong, while the transmission from activity to inflation is weak.",
    "Simulations under uncertainty about the extent of the pass-through suggest monetary policy can play a countercyclical role in the face of depreciation shocks at a moderate inflationary cost, provided inflation expectations remain anchored.",
    "Substantial pass-through from the peso depreciation during 2013-15 to overall inflation.",
    "Amplification channel: widespread indexation in non-traded goods markets increases inflation response.",
    "Limited role of wage indexation for the inflation dynamics in this episode.",
    "Without the depreciation, inflation would have remained inside the central bank’s target band.",
    "Monetary tightening following a depreciation shock:",
    "Monetary policy faces a trade-off when responding to depreciation shocks: mitigating inflationary effects can incur sizable output costs.",
    "If inflation expectations remain anchored, monetary policy can act countercyclically against depreciation shocks while accepting a moderate inflationary cost.",
    "Policy design should account for the amplification role of indexation in non-traded goods when assessing pass-through and the appropriate policy response.",
    "Simulations consider uncertainty about the extent of exchange rate pass-through.",
    "Results indicate:",
    "**Wp16129**"
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