When, in 2019, Sebastián Piñera referred to Chile as an oasis in the middle of a Latin America with great economic and political adversities, he never thought about the events that would follow.
In the last months of that year, there was a social outbreak full of protests and clashes between the armed forces and public order with the citizens. According to the General Secretariat of the Presidency, the economic cost to the country of the demonstrations, acts of vandalism and violence was around 3 billion dollars. By reviewing the monthly index of economic activity (Imacec) it is possible to assess the drop in commercial activity in Chile at the end of that year, as a result of social discontent.
The arrival of Covid-19 in Chile in 2020 and the health measures adopted added to the effects of providing a repeated drop in economic activity in the country, which had already suffered a lot in 2019. This situation lasted until the middle of the year, since in July it was authorized the use of pension funds for taxpayers, which gave the economy a breather with the resources that were injected into it.
However, this was not enough, as the double-digit unemployment experienced throughout 2020 (and which would last until May 2022) eroded people’s economic autonomy and led to pressures to authorize a second and third withdrawal of pension funds in December 2020 and April 2021.
This meant a cash injection of around $50 billion by August 2021 from pension fund withdrawal/redemption. This increase in private liquidity, added to the transfers and aid provided by the government to families and companies since 2020, generated an increase in the monetary base, doubling it during the second half of 2021.
Although the increase in liquidity can be a factor that propitiates the increase in prices, given that there is a growing demand, the product of an increase in the extraordinary payment capacity and a constant or diminished supply of goods and services, this is not the only factor. . In fact, much of the 7% increase in inflation experienced in Chile so far in 2022 is due to exogenous factors.
International prices have risen as a result of the pressure exerted by the armed conflict between Russia and Ukraine, which began in February. This conflict acted on two fronts, which accentuated the effects of the health crisis. On the one hand, it led to an increase in the value of food and fuel (elements sensitive to the population). On the other hand, it generated a rupture in the supply chain and an increase in the value of materials (sensitive elements for producers).
In addition, we must not forget the scarcity of final goods worldwide, due to the draconian sanitary measures adopted by China in an attempt to minimize the number of infections by Covid-19 and the lower-than-expected economic growth in the second half of 2022, which pressures the rise in the value of the dollar in the case of Chile. The deterioration of the exchange rate favors exports, but makes imports more expensive, which, in turn, translates into a pressure factor for the prices of goods that are demanded in the interior of the country.
Currently, one of the functions of central banks is to control inflation through monetary policy strategies in order to maintain people’s purchasing power over time, mitigate fluctuations in unemployment and favor the production of goods and services.
The Central Bank of Chile, as a way to combat inflation levels, has increased the monetary policy interest rate, reaching 9.75% on July 14, the highest in the last 20 years. By raising the interest rate, productive investment becomes more expensive, consumer spending and the desire to keep cash are discouraged.
However, if this type of strategy continues, Chile could face a scenario of stagflation — that is, economic stagnation with high inflation. Economic theory mentions the presence of certain conditions that combine for this to happen: several quarters of falling or declining GDP, rising prices, high interest rates, devaluation and a negative trade balance.
An alternative to monetary policy is the control that governments can eventually exercise over the rise of both wages and prices — the famous economic pacts. However, it is difficult to maintain them over time, and given the contractual and labor heterogeneity, it becomes complex to determine who or what functions would be outside this control.
Whatever formula is used to control inflation, it must consider the effect on society’s well-being and the repercussions for it, in the short and medium term.
*Translation from Spanish by Giulia Gaspar
