Comfort in floating: taking stock of twenty years of freely floating exchange rate in Chile

Abstract

Chile offers an example of a country that has overcome the fear of floating by reducing balance-sheet mismatches; enhancing financial-market development; and improving monetary, fiscal, and political institutions; while strengthening policy credibility. Under the floating regime, Chile’s economic adjustment to external shocks appears significantly improved, and its exchange-rate passthrough has substantially declined. Our results reinforce the case that moving to a clear and credible floating regime can be associated with a reduction in the fear of floating via economic transformation (like smaller balancesheet mismatches, a larger hedging market, and a lower exchange-rate passthrough).