Sources: Corporation for Technological Development of Capital Goods (CBC) and National Statistics Bureau (INE). 4  BIS Review 39/20086  Copper $ MM; US cents/Lb.) 900  450  600  300  300  150  0  0 96  98  00  02  04  06  III  07  Mining investment (2)  III  08 (1)  Copper price  (1) Figures as of February. (2) Includes investment in buildings, engineering, equipments and others. Sources: Corporation for Technological Development of Capital Goods (CBC) and Bloomberg. For countries that are net exporters of commodities, the impressive price hikes results in a positive terms-of-trade shock. In Chile, terms of trade have increased by almost 70% in the last three years, mostly due to the sharp increase in copper prices. Not surprisingly, this shock has resulted in an appreciation of the real exchange rate. However, the macroeconomic policy framework, as well as particular characteristics of the Chilean mining sector, has mitigated the effects of terms of trade gains on domestic demand, inflation and the exchange rate. Half the income from copper (after tax) goes to foreigners and almost none of it remains in Chilean territory. The other half is from a state-owned enterprise and taxes from private companies. There is a fiscal rule for government spending that stipulates that all income above certain long-term price has to be saved. Government surplus has been 7% on average the last three years, and foreign assets reached about 13% of GDP in 2007.
If agents expect inflation to go down towards a target, they will price their goods accordingly and inflation persistence will be lower. If, in contrast, agents expect inflation to persist in high levels, they will price goods higher, making inflation more persistent and more difficult for the central bank to bring it down. As stated in Bernanke (2007): “a one-off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent “wage-price spiral”. With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation, but only to a change in relative prices.” Credibility of the target in an inflation-targeting regime is therefore a key asset. If we were to give up on the inflation commitment, the future adjustment of interest rates to rein in inflation would have to be much larger, with adverse consequences on economic activity and relative prices, in particular the exchange rate. Indeed, we have witnessed many experiences where a persistent rise in inflation has required strong monetary policy actions, the most notable case being the great inflation of the USA in the 1970s and early 80s. The control of inflation in Chile has also come with a decline in inflationary persistence. Therefore, a credible commitment to price stability brings along output stability. Output stability, in turn, is an important factor to foster economic growth and the consequent social progress that comes with it (Ramey and Ramey, 1995, and Fatas, 2002).