Chile: Chile's central bank governor :Rodrigo-Vergara

The expansionary monetary policies of developed nations is making life difficult for those in the developing world. So says Chile's central bank governor, who is keen to resist a 'currency war' – for presently – and as well tells us why central bank independence is of great importance.

With a gross domestic product (GDP) expansion of 5.5% in 2012, according the central bank, and a labour market close to full employment, Chile’s economy has been enviable even by Latin American standards. But the country is not immune to external economic issues, and its currency is starting to feel the effects of quantitative easing in the developed world. Talks of ‘currency wars’ from a number of nations were echoed by Chilean finance minister Felipe Larrain at the World Economic Forum’s annual conference in Davos this year, where he said he would support the central bank’s actions to relieve pressure on the peso.

In an interview with us in Santiago, Chile's central bank governor Rodrigo Vergara says the institution is open to various options in this respect, but he underlines the importance of central banks retaining their independence – in both Chile and elsewhere.

Q: What’s the result of international expansionary monetary policy on Chile?

A: A concern that I have, in the case of Chile, and the concern of a lot of emerging market economies, is the effects that this ultra-expansionary monetary policy in the developed world is having. Close-to-zero interest rates and quantitative easing – each other week we hear of from presently on an extra country introducing a new quantitative easing policy – are putting pressure on the exchange rate and investment prices in a lot of other nations. A lot of economies are taking measures [to fight] this.

Q: Will Chile declare ‘currency war’ too?

A: This is a concern, not only for Chile and other emerging markets, but as well for some developed economies, such as Australia, Canada. We have a flexible exchange rate system, but at the same time as you have this differential in interest rates [between us and] developed economies and, in addition to that, you have additional quantitative easing, you start getting capital inflows, which produce an appreciation of the currency and have an result on financial markets, such as the creation of credit booms and investment price booms. We are not intervening in the exchange rate market, we have not introduced, as other nations have done, capital controls, but we don’t policy out any instrument.

Q: How significant is the independence of central banks?

A: I’m a firm believer in central bank independence. From a long-term perspective, I definitely think that central banks should remain independent. It’s good for the economy. There is always coordination [with the government] and that too is a good thing, but it doesn’t mean that [the central bank is] dependent on the government. It means that it shares a view, that it tries to coordinate policies, but if it has to take a decision in a certain direction, it takes that decision [independently]. Otherwise, in the long term, you would [inevitably] end up with high inflation.

Q: What do you think of alternatives to inflation targeting, such as nominal GDP targeting?

A: I’m very sceptical about that. Targeting nominal GDP is much additional complicated than targeting inflation. You have to be mindful that nominal GDP is the sum of two things: real GDP, which eliminates inflationary effects and brings current-price GDP to base-year prices, and the GDP deflator [a measure of the level of current prices]. As well, with nominal GDP, you don’t have data with the same frequency as you do with inflation, where you have data each month. You usually have nominal GDP data quarterly. It is as well additional complicated to explain to the public. A simpler target is a better target.

Q: What is the major challenge of central banks at the moment?

A: One challenge, mostly in the developed world, is to have a monetary policy that helps to spur economic increase. But an extra significant challenge is how to transaction with financial stability. Financial stability has become a large topic next the crisis and it is basically a central bank issue. A lot of central banks have financial stability in the mandate. In Chile we have a narrow mandate that is related mostly to the stability of the payments system. With an inflation target mandate, or price stability mandate, you have specific targets that are very clear and well known to everybody. In the case of financial stability, the target is broader, it is additional difficult to define.

And it is not only a matter for the central banks. In Chile, we’ve created the Financial Stability Council, which the ministry of finance, the central bank, the superintendence of banks, the superintendence of securities and the superintendence of pension funds amount participate in. It has been in existence for the completed year. I would say that the major challenge for the next is probably how to make a financial stability mandate work for central banks.