## Outside the Band: Depreciation and Inflation Dynamics in Chile

_IMF Working Papers, July 6, 2016_

## Source details

**Canonical URL:** [Outside the Band: Depreciation and Inflation Dynamics in Chile](https://www.imf.org/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059/index.json)
- [Bundle manifest](/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059/bundle-manifest.json)

## Bibliographic details
- Authors: Esther Perez Ruiz
- Published: July 6, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498350976.001

---

### Summary
- 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.

### Key findings
- 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:
  - Strong negative effect on output (activity responds strongly to interest rates).
  - Weak effect on inflation (activity-to-inflation transmission is weak).

### Policy implications and recommendations
- 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 and scenarios
- Simulations consider uncertainty about the extent of exchange rate pass-through.
- Results indicate:
  - Monetary policy can be countercyclical under moderate inflationary consequences.
  - Anchored inflation expectations are a key condition for a successful countercyclical policy response.

---

## Content in this bundle

- **Wp16129**
  - [Wp16129 (Markdown version)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16129.pdf.md){rel="alternate" type="text/markdown"}
  - [Wp16129 (PDF)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16129.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/outside-the-band-depreciation-and-inflation-dynamics-in-chile-44059_