Exchange Rate Policy in Chile: From the Band to Floating and Beyond

With the exemption of adopting a foreign currency, Chile has experienced virtually all the menu of options of exchange rate policies in the last 40 years. The quest for a reasonable exchange rate policy has been inspired in part by the different goals that, over time, policy makers have attempted to achieve with this policy. After almost of decade of co-existing inflation targeting and an exchange rate band, in 1999 the Central Bank of Chile gave up the exchange rate band and replaced it with a policy of floating. This paper addresses two main questions: (a) Why was the band abandoned and, why did it take so long to accomplish and (b) How has the floating regime worked so far? The last question involves accounting for the possible appearance of “fear of floating” by the macroeconomic authorities, as well as evaluating the regime in three critical issues: exchange rate passthrough to domestic prices, exchange rate volatility, and balance sheet effects. In the final section, the paper illustrates the operation of the exchange rate system in the face of regional contagion effects.