Chile Since 1999: From Counter-Cyclical to Pro-Cyclical Macroeconomics

In the 15 years from 1999 to 2013, Chilean GDP growth averaged 3.9%. Although this was above the 3.2% Latin American average, it represented a sharp drop from the country’s sustained 7% annual growth in 1990–1998, the first 9 years after its return to democracy. This article seeks to explain this significant outcome reversal. Given the absence of deep backwards steps in the microeconomic approach, we focus on macroeconomic policies. Two cycles are distinguished: (a) 1999–2007, between contagion from the Asian crisis and a peak in economic activity in 2007 before the contagion from the global crisis, and (b) 2008–2013, between the start of recession in 2008 and a GDP peak in 2013, just before a significant new deceleration. We show that the adoption of inflation targeting combined with full opening of the capital account and exchange rate liberalisation successfully kept inflation low and avoided balance of payments crises, but implied that the economy was usually operating below potential output, while the exchange rate and current account became extremely unstable. Pro-cyclical financial markets and the price of copper again became active channels of transmission of external instability to domestic macroeconomic markets. On the other hand, fiscal policy moved from being rather neutral to effectively counter-cyclical in 2009 and, more recently, to pro-cyclical. Pro-cyclicality discouraged capital formation and productivity. Real macroeconomic instability was a determinant variable underlying the worsened growth outcome.