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Control movements of capital and “encaje” in Chile

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Latin America has faced many economic ills since the 1980s debt crisis, the impact of Mexican and Asian crises, hyper inflation etc. Chile seems to have suffered less in the 1990s than its closest neighbors.

One can speculate that the encaje, system of capital controlled by the establishment of unpaid reserve requirement, helped make Chile immune to economic and financial failures.

This work is structured around four main questions: what controls movements of capital? Why has Chile resorted to encaje? What is the mechanism? What are the conclusions that can be drawn?

Broadly, there are two main types of capital flows, the long-term flows, where these flows are considered stable and relatively close to the real economy that is so desirable. The second flow is the short-term flows: These are flows that are considered speculative and potentially responsible for destabilizing the real economy and they are disconnected.So these are those that governments will try to control.

The desire to control capital flows in the short term macro serves several purposes, among which may, among other things, distinguish the desire to discourage capital inflows to mitigate upward pressure on the exchange rate that will reduce risks associated with the sudden reversal of flows and the desire to maintain an independent monetary policy.

It is difficult to assess the macroeconomic consequences of such a mechanism, however, it seems, according to an IMF study published in 2007, that the control of movements of capital flows maintained over a long period would generate a three-level microeconomic cost. It would make it difficult for small companies wishing to raise capital (cost of capital). It also causes a distortion and a relaxation of market discipline. Finally, it would cause a decline in international trade.

Measures to control capital flows in the short term have been taken during the 1990s, in several emerging countries trying to cope with the influx of foreign capital. The most emblematic example is that of the Chilean encaje that will be studied in this paper.

Tags: Chile, control movements of economy; the Chilean encaje system

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