Fiscal stimulus, monetary stimulus and a game of chicken

CHILE - Report 24 Jun 2021 by Igal Magendzo and Robert Funk

The economic recovery that started in July 2020 was interrupted in late March 2021 by a resurgence of the contagion, and the re-imposition of mobility restrictions. April’s Monthly Index of Economic Activity (IMACEC) fell by less than expected, and considering that national mobility increased in May, we expect the IMACEC to return to positive monthly variations. Despite political uncertainty and the weakness of the labor market, consumption should remain dynamic, supported by the third pension savings withdrawal, and the sharp increase in government transfers. But investment will remain sluggish.

The increased intensity of mobility restrictions during April was also reflected in weak performance of the labor market. The drop in the unemployment rate, from 10.4% to 10.2%, is largely because in quarantine people abandoned the search for work. Wage dynamics in April were not favorable either. This confirms the absence of inflationary pressures coming from the labor market -- very unlike the upward trend observed in Q1 2021, and the wage bill remains sluggish.

CPI’s 12-month variation increased again in May, from 3.3% to 3.6%. This increase is explained by the low base of comparison. To a large extent inflation has been driven by the increase in the price of energy. The strong imports of consumer goods should limit excess demand for durable goods, but government transfers and withdrawals from pension funds will operate in the opposite direction. The future evolution of inflation is highly uncertain, especially due to the volatility of domestic politics, and its effect on capital flows, potential growth and consumption.

In its last IPOM, the Central Bank made some surprising increases in its projections. The Bank’s base scenario now contemplates a 150 bp increase in the Monetary Policy Rate this year, and to gradually approach 2.75% by the end of 2022. We believe that at least part of the strong hawkish correction in forecasts corresponds to a strategic move intended to send a message to fiscal and legislative authorities. We expect inflation and growth this year to be lower than the Central Bank’s base scenario, and that both the credit market and the labor market will remain weak. Consequently, we expect increases of the TPM of 25 bp in each of the four meetings in H2.

There are strong opposing forces affecting the currency. Growing sociopolitical uncertainty, expectations of rising sovereign debt, the repatriation of part of the pension funds by the AFPs in the context of the withdrawals, and interest rates rising in the United States, are pushing the value of the currency downwards, while income from exports, government dollar sales ($150 million a day that will continue at least for the next three months) and rate hikes push it upwards.

Having elected local authorities, governors and the members of the constituent assembly, attention now turns to presidential politics. The presidential primary campaigns are well underway, and several candidates have published their election platforms. Most noteworthy is the document released by the Communist Party’s candidate Daniel Jadue, who has been narrowly leading in the polls. Jadue’s plans include many tax hikes as well as new taxes, increasing the minimum wage, profit redistribution and plans to “regulate” the media. Jadue’s real challenge is to expand his electoral support beyond his base. It is not at all clear that his radical election platform will help in that regard.

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