OECD Economic Outlook, Volume 2021 Issue 2

Chile

The Chilean economy is growing strongly, fuelled by a rapid vaccine rollout, a large fiscal stimulus, high commodity prices and the short-term impact of extraordinary pension fund withdrawals on consumption. GDP growth is expected to reach 12% in 2021 and slow towards 2% in 2023, as monetary and fiscal policies tighten. Inflation has risen amid buoyant domestic demand and supply bottlenecks, but is projected to slowly return to the target of 3% by early 2023.

In the short term, the main challenge for macroeconomic policies will be to avoid overheating. The planned fiscal adjustment is appropriate. Focusing support on those firms and households that need it most would go in this direction, but a reform to raise higher public revenues is needed to accommodate higher social spending needs. Monetary policy tightening, which has started, should continue to reach a neutral stance in early-2022 to ensure that inflation returns to target. Strengthening access to quality education, life-long learning and job search support would help to address increases in inequality and foster a stronger recovery of employment.

Demand is expanding vigorously while inflation has increased

One of the fastest vaccination rollouts in the world has substantially reduced COVID-19 cases and deaths, allowing an almost full reopening of the economy. Household consumption is thriving on the back of strong fiscal support to households and continuous pension fund withdrawals. Economic activity recorded strong growth in the third quarter of 2021 with vigorous retail trade and services growth. Short‑run business confidence has risen significantly supporting investment, especially in machinery, in a context of strong demand and reopening of the economy. The strong increase in domestic demand led to an acceleration of headline and core consumer price inflation well beyond the central bank target of 3%. The peso depreciation and higher energy prices have added to inflationary pressures, and inflation expectations have started to rise. Wage pressures have emerged as firms are facing difficulties in hiring workers. The unemployment rate, at 8.4% in September, is almost 4 percentage points lower than a year ago. However, around a third of the jobs lost during the pandemic have yet to return, while labour force participation is well below pre-crisis levels.

Chile: Economic activity and inflation indicators

1. Consumer Price Index (CPI) excluding energy and food products.

2. Inflation expectations are based on the Survey of Economic Expectations, which is a monthly survey of a group of academics, consultants and executives or advisors of financial institutions carried out by the Central Bank of Chile.

Source: OECD Economic Outlook 110 database; CEIC; the Central Bank of Chile; and INE.

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Chile: Demand, output and prices

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Policy stimulus is being withdrawn

Fiscal policy reacted vigorously to support households and firms during 2021, with overall measures reaching 8% of GDP, including a cash transfer reaching 80% of Chilean households. This support is expected to reduce poverty and inequality significantly. Fiscal consolidation will appropriately reduce the structural budget deficit from 11.5% of GDP this year to 3.9% in 2022 and by 1% of GDP per year starting in 2023, to stabilise debt around 40% of GDP. Rebuilding fiscal buffers and the need to increase spending in areas with longstanding challenges, such as education and training, social protection, and public infrastructure will require gradual and permanent increases in public revenues. The Central Bank of Chile has raised the policy rate by 225 basis points this year, to 2.75% in October, and should continue raising rates to reach a neutral level by early‑2022.

Economic growth will moderate

Economic growth has been driven by buoyant private consumption in 2021 on the back of fiscal expansion, pension fund withdrawals and loosened mobility restrictions. High copper prices and measures to accelerate private investment projects have boosted fixed investment. Without reforms to enhance productivity, growth will slow over 2022 and 2023 as fiscal support and the savings and liquidity accumulated from the pension fund withdrawals fade, financial conditions tighten and high uncertainty depresses investment. Employment is projected to continue recovering at a slower pace with pre-pandemic levels regained only in early-2023. Inflation will converge to the 3% target early in 2023 as domestic activity decelerates. Downside risks to the outlook include more persistent inflation and overheating of the economy. The outcome of the constitutional process and the presidential elections at end-2021 are sources of uncertainty. A stronger‑than-expected adjustment in China’s construction sector could lower copper prices and exports. A fourth wave of extraordinary withdrawals from pension funds would further reduce already low old‑age pensions, increase inequality and require pension funds to liquidate assets, further reducing the saving rate and exacerbating already observed negative effects on financial stability. Moreover, the short‑term demand boost will exacerbate the overheating of the economy. Upside risks to growth include a faster resolution of international supply bottlenecks and further materialisation of pent-up demand.

Policies to boost long-term growth are needed

Reducing high inequality and strengthening economic resilience and growth will require a comprehensive reform agenda. Long-term growth would benefit from streamlining complex regulatory procedures to expose firms to competition, innovation and digital tools. Strengthening public employment services, unemployment benefits and the training system would support workers, particularly vulnerable ones, in finding quality jobs. Meeting the 2050 carbon-neutrality target will require sustained efforts to decarbonise the energy matrix and electrify transport. Planned reforms to raise pension benefits for low‑income earners will promote inclusiveness, but a deeper reform of the pension system will be inevitable to address structurally low pension benefits and high public financing costs that have been aggravated by the pension fund withdrawals.