José De Gregorio: Adjustment in the global economy Keynote address by Mr José De Gregorio, Governor of the Central Bank of Chile, at the 2011 Institute of International Finance (IIF) Latin American Economic Forum, Calgary, 27 March 2011. *  *  *  I am grateful to Luis Oscar Herrera, Enrique Orellana and Tatiana Vargas for valuable comments. Thank you very much for the invitation to speak at this 2011 IIF Latin American Economic Forum. The last few years have been the most challenging for economic policy around the world in many decades. From an unprecedented inflationary shock in 2007–08, the global economy went through a financial crisis and a recession in 2008–09, of a scale not seen since the Great Depression. Now, we are experiencing a process of recovery with strong inflationary pressures and tensions in the world economy as a result of asymmetries in this process. The purpose of my talk today will be the global adjustment, how it has been proceeding and what the current challenges for policymaking are, with special focus on the asymmetries and their implications for economic policy. The uneven recovery The world economy is growing unevenly and subject to many tensions. Most advanced economies are recovering from the crisis, but they still have high rates of unemployment and excess capacity, and this is expected to last for some time.
On the one hand, to accumulate reserves, strengthening our international liquidity position, and on the other hand, to provide some transitory relief to sectors that need to undergo an adjustment due to current international conditions. A more debated tool is the use of capital controls. This is particularly important for countries that are going through a period of important net capital inflows, which is not the case of Chile. Capital controls are part of the central bank’s toolkit in EMEs. However, their effectiveness is still a matter of discussion, and instead of discussing this evidence I would like to point to distortions that they may bring about. First, they may redirect capital inflows from controlled segments of the financial system to uncontrolled ones, fostering the shadow banking system. And second, they may generate discriminations in the corporate sector as some firms may have access to foreign financing free of controls, while other firms, especially small and medium sized enterprises, have to seek financing from more expensive domestic sources. Capital controls are not only a macro tool, but have recently been considered “macroprudential” measures as well. Their purpose is to avoid the building up of financial vulnerabilities, in particular currency and maturity mismatches. But, this can also be achieved with regulation directly introduced to prevent these mismatches and through appropriate risk management. Finally, given some recent calls for the use of capital controls in EMEs, there is a collective action problem.