Inflation Dynamics and the Cost Channel: An Application for Chile

The importance of the monetary transmission mechanisms calls for a thorough study of the possible channels by which it can influence the instrument used. The traditional mechanism is an increase in the interest rate that reduces pressures on prices from the demand side. Nevertheless, another possible monetary policy transmission channel exists: the cost channel. An increase in the nominal interest rate affects the cost functions of firms that borrow to pay their workers. This way the effect on the price dynamics of an increment in the interest rate seems to go in opposite direction to the traditional channel. The purpose of this work is to estimate the Phillips curve for the Chilean case, and to verify whether the cost channel affects the dynamics of inflation. The results suggest that the cost channel for Chile is unimportant or very small.