One consequence of this and looser market conditions has been that long-term interest rates have remained at or near record lows (figure 8). Monetary policy has taken into account the inflationary effects of the persistence of the exchange rate shock and gaps – particularly in the labor market – , in order for inflation to converge to 3 percent in the policy horizon. In this context, the Board considers that the convergence of inflation to the target still requires a partial withdrawal of the monetary stimulus, albeit at a more measured pace than estimated in December. In particular, the baseline scenario uses as a working assumption that the MPR will follow a trajectory like the one that can be deduced from the various expectations indicators at the statistical closing of this Report (figure 9). Of course, and as usual, the implementation of monetary policy will be contingent on the effects of incoming information over the projected inflation dynamic. Thus, new data pointing in either direction will trigger the necessary monetary policy adjustments. If, for example, new information translates into projected inflation remaining high for longer, then the withdrawal of the monetary stimulus will be sooner and stronger, and vice versa. Under the assumptions shaping our baseline scenario, our monetary policy will continue to boost the economy throughout the projection horizon. Actually, Chile’s monetary policy rate is the lowest in Latin America and, in real terms, one of the lowest in the emerging world (figure 10).
Some of these problems are dealt with by the new capital adequacy rules in Basel II. Nevertheless, it is essential that the authorities play an active role to ensure better insight. And this is also very much in the market’s own interests. The uncertainty remains The outcome of the current information will depend on how subprime loans are valued in the long term. If interest rate payments from the underlying loans are received as calculated, there is no need to write down the value for this reason. However, it looks as though there will be more defaults on payments than originally feared. In addition, it takes several months from the time that a household defaults on payment of a loan until it reaches the minus side of a balance sheet. Although a number of banks have already made major losses when forced to write down the value of their assets, it will be a long time before all the cards are on the table. There are also considerable problems with valuations. Banks and other investors are to write down the value of their assets, but there are rarely any market prices for the structured products containing mortgages. The valuation problems may force the banks to take bigger write downs than what is motivated by the underlying credit quality. An important factor in all of this is US economic activity.