The big news of the week revolved around, first, the Central Bank’s rate hike and, second, the release of the September Monetary Policy Report, which provides a more detailed explanation of that decision.

In case you haven’t seen it, here’s a summary: The central bank raised its growth forecast for 2021 to the 10.5%–11.5% range, due to stronger growth in consumption (both private and government), driven by government aid, increased liquidity, and the easing of lockdown measures. Against a backdrop of supply constraints, a temporary depreciation of the exchange rate, and rising costs, this also led to an upward revision of the inflation forecast, from 4.4% to 5.7% by year-end. In response, the Council decided to raise the TPM by 75 basis points to 1.5%, with further increases expected at upcoming meetings in both 2021 and 2022.

I must admit that this came as a surprise to me. If you read my last column, you may have noticed. But if one assumes that the Central Bank’s macroeconomic outlook is correct, it is difficult to argue against its decision and, above all, the tone it sets for the future trajectory of monetary policy. Compared to June, household spending has exceeded projections, a trend compounded by expanded government aid and a higher-than-expected marginal propensity to consume (that is, the percentage of income spent on consumption) among the average population. If we add to this the high level of cash holdings—whether in checking or demand deposit accounts—which have not been used to supplement other sources of savings, we can infer that the momentum in consumption will continue.

Furthermore, the exchange rate has depreciated under circumstances in which macroeconomic fundamentals would suggest it should have appreciated. And we’re not just talking about the dollar; this should have occurred on a multilateral basis as well. Many claim that this is “imported inflation,” which is far from the truth. The exchange rate depreciation is, in the Central Bank’s own words, idiosyncratic. I acknowledge the institution’s courage, as it is very difficult to be so straightforward in a situation where none of the other actors are (particularly certain sectors of Congress). The depreciation is due to domestic uncertainty, changes in the rules of the game, the decapitalization of the financial system, and the possibility that local political and economic institutions will ultimately collapse. Is that an international issue? I doubt it.

Given the above, approximately 75% of the reasons for higher inflation would be domestic. The remaining 25% would be international, but given their interaction, the percentages likely overlap significantly, considering that, for example, many supply-side inflationary pressures are often not passed on to final prices because demand conditions do not allow for it. A rise in costs is not always passed on to the consumer: it is absorbed by profit margins. A temporary increase in demand does not always lead to higher prices if inventories are high and there is intense competition among firms. Therefore, it is the overall context that is causing inflationary pressures, and we cannot turn a blind eye to that.

Consequently, in accordance with its constitutional mandate and exercising its powers, the Council decided to raise the TPM by 75 basis points, to 1.5%, signaling its concern about the future and making it clear that further increases will be necessary. How much more? Quite a bit more. So much so that it is highly likely that by March 2022, the policy rate will be around its neutral level (3.25%) and will then exceed that level for a few quarters.

Finally, some warning signs. Given that some—who should stop focusing on the speck in someone else’s eye and see the log in their own—have acted beyond their authority, the inflationary and financial situation could spiral out of control. A fourth withdrawal (or a total withdrawal), a failure to achieve fiscal convergence, or other “creative” measures along these lines would cause imbalances that NO central bank in the world could offset. As the report itself states, “The Central Bank will act in accordance with its mandate to control inflation, a task that will be less costly for the economy to the extent that other actors contribute to restoring the macroeconomic balances that have been lost during the pandemic.” We hope that the country’s last bastion of economic sanity can open the eyes of the rest.

Nathan Pincheira 

Chief Economist at Fynsa