Reforms and macroeconomic adjustments in Chile during 1974–1984

Abstract

This paper provides a background on the main macroeconomic developments of the reform period. After a review of the macroeconomic disequilibrium before the reforms, the paper interprets the macroadjustments. The interpretation covers two distinct periods: 1973–1976, when policy was based on a closed-economy view, and 1977–1982, when macropolicy was increasingly guided by an open-economy model. The paper argues that the setback that Chile suffered during 1982–1983 and the large external debt that was accumulated were the result of two major errors. The first was the use of the exchange rate to stabilize prices without due regard for the incentives for large capital inflows that arose from this policy at a time when international capital markets were very liquid. The second major error was in the second half of 1981. After a large drop in capital inflows, the authorities relied on an automatic adjustment mechanism, by which the monetary squeeze from the reduction in capital inflows would improve the real exchange rate. Because wages were indexed to prior inflation, the adjustment mechanism was bound to create substantial unemployment, as indeed was the case. The paper concludes with the assessment that most of the micro reforms were in the right direction and had the expected result — and the errors were mostly in the design of macroeconomic policies.