Working Paper: NBER ID: w1702
Authors: Sebastian Edwards
Abstract: This paper analyzes the behavior of some key variables during the recent economic liberalization reform attempted in Chile. The paper concentrates on the behavior of the real exchange rate and nominal and real interest rates during the period 1977-83. It is argued that as a consequence of the liberalization of the capital account in Chile in 1979-81, dramatic inflows of financial capital resulted. These capital inflows generated an important increase in expenditure, and a lower relative price of tradables to nontradables or real appreciation. Moreover, it is argued that it is the liberalization of the capital account, and not the adoption of a preannounced rate of devaluation, that generated the dramatic real appreciation of the Chilean currency between 1979 and 1981 . A model to analyze interest rate behavior in a semi-open economy is also presented and applied to the case of Chile. The results obtained suggest that during this period interest rates responded both to open-economy and closed-economy factors. Among the former the increase in the expected rate of devaluation was particularly important.
Keywords: Interest Rates; Real Exchange Rates; Economic Liberalization; Chile
JEL Codes: N26; F31; E43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Liberalization of the capital account in 1979-1981 (F32) | Capital inflows (F21) |
| Capital inflows (F21) | Real appreciation of the Chilean currency (F31) |
| Capital inflows (F21) | Real appreciation to maintain equilibrium in the nontradable goods sector (F16) |
| Interest rates influenced by open-economy factors and closed-economy factors (E43) | Interest rates during capital inflows (F32) |
| High interest rates during capital inflows (F32) | Expectations of devaluation and financial instability (F31) |
| Real appreciation of the Chilean currency (F31) | Real exchange rate (F31) |