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).
One characteristic of the Chilean economy is that changes in costs are regularly passed on to consumer prices. Markets for foodstuff are globally integrated and competitive. In the case of fuels, every week the changes in the international price are passed on to domestic consumers. However, there is a price stabilization fund to smooth out short run fluctuations  BIS Review 39/2008  3  and recently there has been a gasoline tax cut, which ameliorates the large increase in international prices. Finally, the electric power price-setting mechanism is designed to pass changes in upstream marginal costs to retail prices. Electric power rates, affected by a rise in costs, posted an average increase of 23% during 2007 compared with a less than 6% average increase between 2000 and 2006. This context of price flexibility provides the right signals to markets. In the case of Chile, with the increase in the prices of electricity and minerals, several investment projects are in the pipeline, which will propel an expansion of supply. Electricity $ MM; index Dec-98=100) 1200  240  1000  200  800  160  600  120  400  80  200  40  0  0 96  98  00  02  04  06  III  07  Energy investment (2)  III  08 (1)  CPI Electricity  (1) Figures as of February. (2) Includes investment in buildings, engineering, equipments and others.