Inflation and the Trade Balance

Abstract

In an open economy, the short-term stability of domestic prices and that of the external accounts are closely related. Chilean inflation goes back a long way. Traditionally, before the beginning of the import substitution period, during the expansive phase of the economic cycle (which largely depended on external determinants), the amount of money in circulation tended to increase sharply together with, and as a result of, export booms. By contrast, during the recessive part of the cycle, a strong interventionist state coupled with an inadequate tax structure forced successive governments to print money when exports were not doing well in international markets. As the economy became more and more isolated from world markets this latter aspect became increasingly important (Davis, 1963). However, rates of inflation tended to be moderate rather than spectacular, and the economic authorities were not unduly worried about them. In fact, a moderate rate of inflation tax was possibly welcome by most governments, regardless of their ideological persuasion (Méndez, 1970).