Overcoming the crisis

Chile’s robust pace of expansion hit a roadblock when the global financial crisis erupted in mid-2008, and trade flows tumbled. Despite strong fundamentals, Chile was hit severely by the crisis, notably because of its high exposure to commodity prices. Output contracted severely, at a pace similar to that following the Asian crisis, and there was mild deflation. However, the recession was relatively shortlived. The economy bottomed out in mid-2009, helped by the rebound in export prices and a bold macroeconomic policy stimulus. Reflecting past prudent macroeconomic management, Chile was in a good position to easily finance a strong fiscal stimulus, and an aggressive reduction in interest rates was possible thanks to relatively stable inflation expectations. Activity and employment growth are projected to pick up pace in 2010 and reach rates above potential in 2011, but the unemployment rate is likely to stay at a high level and a large negative output gap will persist. Unless the recovery proves significantly stronger than expected, monetary and fiscal policy should remain supportive well into 2010. Ensuing policy tightening should be adapted to the pace of the recovery. Chile should be careful not to withdraw the stimulus too fast, not least to avoid a repeat of unemployment persistence observed after the Asian crisis.