This is an era of global economic uncertainty, and amidst the chaos lies Chile, a unique model for the rest of the world. Chile has a relatively stable financial system and is flexible with fiscal and monetary policy options (notably with the exchange rate). While generally considered a successful economy and growing more than each of Latin-America’s six largest countries, Chile’s economy has nonetheless experienced slowing growth. Many analysts are asking: why hasn’t the Chilean Central Bank lowered interest rates? This is the go-to monetary policy designed to increase consumer spending and ultimately get slowing economies back on track.
Back on October 18th, the Central Bank of Chile made its latest announcement regarding the benchmark interest rate, leaving it at 3.5 percent as it has existed for the entire calendar year. The bank’s decision to maintain the rate at this level is closely aligned with its stance on the current rate of inflation. Inflation rested above Chile’s target of 2 to 4 percent (allowing for sustained economic growth) for a long period of time before rapidly falling to 3.1 percent between July and September of this year. Officials attribute this sudden drop to the peso attaining a stronger value this year, but no matter the cause, the potential for disinflation (a slowed increase in the inflation rate) to spread across all sectors might necessitate a change in monetary policy.
The International Monetary Fund’s (IMF) Mission Concluding Statement forecasts Chile’s GDP to grow at 2 percent in 2017, compared to the estimated 1.7 percent at which GDP grew during 2016. This might account for Chile’s status as a relevant and successful open economy. If economic growth across the globe experiences an upswing, it is in prime position to take advantage of new growth opportunities.
Yet, despite the expected improvement, it might be unwise for the Central Bank of Chile to maintain its comfort with interest rates stagnant at 3.5 percent. Given the state of China’s transforming economy and incoming US President Donald Trump’s rewriting of global trade partnerships, the risk for an unexpected global slowdown is ever-present. Poor performance in economic power houses such as China could result in decreased exports and investment opportunities for Chile - notably its copper exports which account for roughly a third of global supply.
Policymakers at the Chilean Central Bank must take all of this into account when choosing a direction for the benchmark interest rate in 2017. While optimism about the state of surrounding economies can reap big gains for the Chilean economy, lower interest rates would not just appease financial critics, but also help bolster the country’s GDP growth rate.