A strand of research documents Chile’s copper dependence hence significant exposure to terms of trade shocks. Copper prices’ sharp decline and forecast uncertainty since the end of the commodity super-cycle has rekindled the debate on Chile’s adjustment capacity to external shocks. Following Malz (2014), this paper builds a time-varying measure of copper price uncertainty using options contracts. VAR analysis shows that the investment response to an uncertainty shock of average magnitude in the sample is strong and persistent: the cumulative fall in investment from trend at a one-year horizon ranges 2–5.8 percentage points; and it takes between 1½ and 2 years for investment to return to its trend level. Empirical ranges depend on alternative definitions for investment, uncertainty, and options’ maturing time.
The results for the parameter β 4 are presented in Figure 12.11 . It corresponds to the short-term impact of the volatility of copper prices on output volatility. The results for the long-run coefficient ( β 4 /(1- β 1 )) are similar. The figure shows that indeed the fluctuations of copper prices in the 2000s have reduced their effects on output volatility. 11 The point estimate indicates that a 10 percent increase in copperpricevolatility increases output volatility by 1 percent. The increase in volatility observed more recently has the result of
Copperpricevolatility . Volatile copper prices stem from rigid supply and demand, especially in the short run. On the demand side, copper’s physical characteristics make it appealing for a wide range of applications, with aluminum and plastic being only imperfect substitutes. On the supply side, investment reacts with a lag to higher demand given the technical complexity involved in the prospection and construction of a project. Once in train, investment becomes largely irreversible given the amount of capital involved. Furthermore, existing capacity is
-copper-related revenue for 2005–10.
Chile faces high and increasing government revenue volatility due to moderate GDP volatility and very large copperpricevolatility. The standard deviation of output growth declined from 3.5 percent in the 1990s to 2.2 percent in the 2000s, while copperpricevolatility exploded from US$0.2 per pound in the 1990s to US$1.1 per pound in the 2000s.
To deal with large output and even larger copper price shocks, fiscal policy has focused increasingly on shielding government spending from large revenue shocks. Even in the absence of an explicit
Jorge Restrepo, Carlos Garcia, and Mr. Evan C Tanner
It is widely agreed that a fiscal rule should boost discipline and credibility, reduce macroeconomic volatility, and be easily understood. To support such goals, a government may run structural surpluses and accumulate a precautionary cushion of assets on behalf of agents who do not enjoy access to capital markets. As an additional criterion, that level of assets should be bounded. We provide an example of a structural surplus rule that satisfies all such criteria. In our general equilibrium simulations, we show that such a rule benefits credit-constrained consumers but may hurt others.
’s vulnerability to copperpricevolatility and the need to diversify its export base. Under this scenario, the ratio of the PV of debt-to-GDP doubles by 2014, but would still remain below the threshold.
Zambia: Public Sector Debt Sustainability Framework Baseline Scenario, 2009–32
(In percent of GDP, unless otherwise indicated)
Standard Deviation 5/
Public sector debt 1
Mr. Rabah Arezki, Mr. Kaddour Hadri, Mr. Prakash Loungani, and Mr. Yao Rao
Liang (1999) ). The price elasticity of demand for raw materials is generally small because its cost represents only a tiny fraction of the final product price. Therefore, an increase in the demand for finished products will cause a greater increase in the demand for the primary materials used due to the necessary increase of inventories of finished product which will affect the entire production chain.
Relative CopperPriceVolatility, 1874-2005
Relative Gold Price Volatility, 1652-2005
Relative Lead Price Volatility, 1652-2005
International Monetary Fund. Western Hemisphere Dept.
-Based Fiscal Frameworks for Latin America
Latin American countries adopted rule-based fiscal frameworks over the course of the past decade to put an end to a long history of fiscal profligacy . Aimed at addressing debt sustainability concerns and managing commodity price cycles, they paid little attention to the business cycle. They primarily targeted balanced budgets or deficit ceilings, and were reinforced at times with caps on subnational borrowing and current expenditure growth. Only Chile adopted a structural balance rule which, aside from addressing copperprice
Fiscal Responsibility Law to promote the needed budget discipline by constraining policymakers’ discretion. The law would put in place three complementary rules that would function as a fiscal “circuit breaker” and would work together to ensure fiscal discipline:
A ceiling on the “structural” deficit . The structural deficit adjusts the deficit for swings in copper prices. Specifically, revenue projections would be based on a “normal” or smoothed copper price instead of the actual copper price. This helps insulate the budget from copperpricevolatility, and
expenditure increase has been carefully matched by additional resources, and because the Copper Stabilization Fund has protected fiscal revenue from copperpricevolatility. 12 The tax structure has been modified slightly in the past 10 years ( Figure 7.5 shows the evolution of Chile’s main tax rates), leading to a moderate increase in tax revenue as a percent of GDP.
Figure 7.5 .
Chile: Tax System
Source: Chilean Ministry of Finance.
The fiscal “payback” of this investment in stability has been the significant growth in fiscal revenue due to