At a time when our monetary policy was working hard to prevent the propagation of the inflationary shock to other prices, we suffered the onset of an international financial crash of a magnitude not seen since the Great Depression of the 1930s. The sharp fall in demand, caused largely by a crisis of confidence and an unprecedented rise in volatility and uncertainty, caused a severe downturn in the world economy and in Chile. The downturn was especially strong in the last quarter of 2008 and the first four months of 2009. The drop in output during that period was determinant in the recession we saw last year. Macroeconomic policies reacted strongly. However, they could do little to counteract the immediate effects of this phenomenon, not only because of the lags with which they operate, but especially because of the sudden nature of the collapse in demand. Still, and as we have previously claimed, a monetary policy based on a flexible inflation targeting regime – that allows for the accommodation of shocks over a reasonable period of time –, a floating exchange rate, a solid financial system and a fiscal policy that saved during the good times, were key to ensuring a rapid and sustainable economic recovery. Our macroeconomic policy scheme allowed us implementing an unprecedented stimulus, which has had important positive effects on output, within a context of well contained inflationary pressures. The national economy began recovering by the middle of the second quarter of 2009.
Domestically, financial conditions showed early signs of normalizations, with lending increasing from month to month, low interest rates and credit standards that were more expansionary during the fourth quarter of 2009 than during the preceding quarter (figure 3). The value of the peso has fluctuated significantly since December, partly owing to global phenomena, but largely due to domestic factors. After continuing with the process of  2  BIS Review 61/2010  appreciation that began in early October, the peso peaked at the beginning of January. It then depreciated sharply, driven by increased tensions in world financial markets and by changes in the hedging strategies used by pension funds. The depreciation trend reversed during the course of February due to a decline in external tensions and a change in pension funds’ purchase flows. After the earthquake and tsunami, the peso experienced further fluctuations due to changes in private expectations about how the reconstruction would be financed and how insurance claims would be paid. The importance of idiosyncratic factors is apparent in multilateral indicators that measure the peso’s movements with respect to the dollar and other currencies, which are showing smaller variations than those of the peso/dollar exchange rate (figure 1). Annual CPI inflation returned to positive territory earlier than what had been foreseen in December (figure 2). Core measures, in particular the CPIX1, continued to display low month-on-month variations.