From Autonomy to Cooperation: The Transformation of Policy Objectives at Chile’s Central Bank in the 1930s

Scholars have repeatedly asked: Should central banks bear responsibility for erroneous monetary policies? It must be clarified that the ultimate authority to amend monetary systems and organizational statutes rests with the government—not the central bank—and the central bank merely acts in accordance with the law. Archival records from the central bank reveal that its board members continued actively debating the economic situation and the institution’s role, closely monitoring the overall economy, reporting developments to the authorities, and proposing feasible policy options. Initially, board members unanimously supported a contractionary monetary policy; in May 1931, they even submitted a memorandum to the executive branch urging further cuts in public expenditure and seeking new loans. Yet just two months later, facing a run on the peso, it was precisely the board that drafted the foreign exchange control bill—promptly enacted by the government as Decree No. 4973 on 30 July 1931, establishing the Foreign Exchange Control Commission. Coupled with Chile’s sovereign default on external debt on 16 July 1931, this was one of the most consequential decisions of the period, effectively ending the gold-exchange standard: money supply was no longer tied to the central bank’s international reserves. The measure aimed to enhance flexibility in managing the money supply, expand the scope for discounting and rediscounting, and allocate scarce foreign exchange rationally to critical imports. Although intended to increase the flexibility of monetary policy, this law in fact marked the end of the ‘currency defense’ phase and the beginning of the ‘fiscal dominance’ phase. From late July 1931 to December 1932, political instability—including 15 changes in the Ministry of Finance—forced the central bank to monetize fiscal deficits, fueling inflation. Finance Minister Pratt Cavañal’s remarks clearly captured this institutional feature: in August 1931, he declared to the board that the urgency of the moment required prioritizing fiscal revenue over monetary stability—i.e., adopting an expansionary monetary policy. During this period, multiple laws authorized large-scale credit extensions to fiscal and sectoral lending institutions, consistently breaching the central bank’s statutory operational limits. Under fiscal dominance, Chile lacked a coherent conceptual framework for monetary policy management—a stark illustration of how crises can catastrophically disrupt economic policymaking. The incumbent government responded hastily, attempting to offset the effects of the Great Depression. A distinctive feature of Chile’s institutional setup was that economic decision-makers ignored the operating principles of fiat currency systems, especially the inflationary impact of deficit monetization. Historical records show that the Ministry of Finance believed newly issued currency would not affect the peso’s value so long as foreign exchange reserves remained stable under exchange controls—and thus repeatedly requested large fiscal credits. The result was a rapid shift from deflation to inflation, with monthly average inflation reaching 15.6% between July and December 1932. Although the board persistently issued warnings, the central bank’s capacity and independence to combat inflation were minimal—a hallmark of fiscal dominance. Previously frequently used discount and rediscount rates were raised only in September 1932, when inflation spiraled out of control—yet the adjustment had limited effect. A pivotal moment during the fiscal dominance phase was the formal abandonment of the gold-exchange standard on 19 April 1932. Foreign exchange controls, expansionary monetary policy, and initial price increases rendered a return to the legal parity stipulated in the 1925 Currency Law unfeasible. Nine months later, the new Currency Law No. 5107 was promulgated, placing foreign exchange operations under the supervision of the International Exchange Commission and suspending the convertibility of banknotes. The practical effect was a nominal depreciation of the peso by 27% against the pound sterling and by 26% against the U.S. dollar. As early as September 1931, the board had already anticipated that returning to the original parity would be unfeasible, as it would require implementing public expenditure cuts deemed ‘unbearable’—though board members such as Luis Matte continued urging every possible effort to maintain the original parity.

North–South Divergence in Monetary Policy Becomes Increasingly Pronounced

Federal Reserve Chair Jerome Powell reaffirmed the Fed’s 2% inflation target, emphasizing that although inflation has eased, it remains too high. Even before this meeting, intense debate had surrounded whether the 2% target remains appropriate in the post-pandemic era—‘2% is 2%’ appears to have become the Fed’s non-negotiable bottom line and guiding objective. Although the European Central Bank (ECB) stated, after its July rate hike, that this might be its final increase, ECB President Christine Lagarde clarified in the subsequent press conference that the ECB’s monetary policy stance could involve maintaining current interest rates—or even raising them further—but would not include rate cuts. At the Jackson Hole symposium, Lagarde reiterated: ‘In the current environment, the ECB stands ready to set interest rates at a sufficiently restrictive level for as long as necessary to ensure inflation returns to our 2% medium-term target in a timely manner.’ The Bank of England is pursuing increasingly aggressive monetary policy: following its scheduled 25-basis-point rate hike in early August, it continues to assert that this step will help avoid a recession. With labor market pressures only beginning to ease—and job vacancy rates still falling toward more normal levels—the BoE retains little room to pause further hikes. The Bank of Canada, in its July rate hike announcement, indicated that the rebalancing of supply and demand is expected to be delayed by three quarters relative to earlier projections, now anticipated only by early next year. Moreover, inflation is proving stickier than previously expected; a return to the target range is now projected only by mid-2025. While many observers believe this may be the Bank of Canada’s final hike, a meaningful decline in interest rates is still expected to take considerable time. Following its decision to hold rates steady in early August, the Reserve Bank of Australia (RBA) forecasts that although inflation is declining, it will still take 24 months—or possibly longer—to fall from its current 6% level to the 2–3% target band, with considerable uncertainty surrounding the timeline. The RBA also noted it will assess the lagged effects of previous rate hikes and may need to tighten policy further. Emerging Economies Enter a Rate-Cut Cycle While advanced-economy central banks continue hiking rates and maintaining restrictive monetary stances, an increasing number of investors are observing starkly different policy positions among emerging-market central banks. Having adopted more proactive measures to counter inflationary pressures since early 2021, most emerging markets have experienced more pronounced disinflation. Accordingly, data released by the Bank for International Settlements (BIS) at the end of July show that, since the start of this year, 11 central banks—including those of Brazil, Chile, and Indonesia—have either implemented further easing or held their benchmark rates steady. India, Morocco, Mexico, and Malaysia, having raised rates earlier this year, have since maintained their benchmark rates unchanged. Meanwhile, the Philippines, Thailand, South Africa, and Serbia remain on a hiking path, having raised rates twice consecutively. Data indicate that, as of end-July, emerging-market central banks collectively executed 24 rate hikes totaling 1,725 basis points—a figure far below the 92 hikes and 7,425 basis points recorded in 2022. Current trends suggest that the majority of emerging-market central banks—including those of Indonesia, Mexico, South Africa, India, and Poland—will hold benchmark rates steady and opportunistically initiate rate cuts ahead of the Federal Reserve abandoning its hiking cycle or signaling future rate-cut expectations. Meanwhile, certain emerging economies—including Brazil and Chile—have demonstrably outpaced advanced economies in using rate hikes to curb inflation, thereby achieving a degree of ‘generational divergence’ relative to the Fed’s monetary cycle—and have already transitioned into a rate-cut phase aimed at stimulating economic growth.

Chile Holds Key Rate as Growth Fades and Inflation Picks Up

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Chile's central bank maintained interest rates at 4.5% amid rising inflation and economic stagnation. Mining output fell and fuel prices surged due to external shocks, impacting the energy-dependent economy.

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Chile Holds Key Rate as Growth Fades and Inflation Picks Up

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