Credibility and Inflation Targeting in Chile

Abstract

In this paper we present new evidence on the recent changes of the inflationary dynamics for the Chilean economy. We show that price rigidity has increased while the degree indexation based on past inflation has decreased over time. We also show that the passthrough from the exchange rate to traded goods inflation has decreased in recent years. We argue that these changes are related to an enhanced credibility of the monetary policy that has improved the tradeoff faced by the Central Bank. Consistently with this hypothesis, we show that the policy rule that characterizes the behavior of the Central Bank of Chile has become more aggressive in fighting inflation deviations from the target, and also more forward-looking.