Between 1988 and 1998 Chile's average economic growth reached 7.8%. Nonetheless, growth decelerated sharply after the Asian Crisis; since 1998 the average economic expansion was only 3.7%. Along with this deceleration, the volatility of the economy was cut by more than half. Using a formal empirical analysis, this paper investigates the role that the adoption of both a floating exchange rate scheme and the use of the Structural Surplus Rule had in transforming Chile into a less volatile economy. Our results show that the introduction of the fiscal rule allowed for a reduction in the volatility of GDP growth by one third. On the other hand, the introduction of the flexible exchange rate mechanism contributed to reduce the volatility by one quarter. Thus, jointly, both policy reforms diminished the volatility of the Chilean economy by almost 60%. These results are robust to alternative specifications and endogeneity problems in some of the explanatory variables.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics