Latin America and the Global Financial Crisis

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Latin America and the Global Financial Crisis

• Valpy FitzGerald
• University of Oxford

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The global financial crisis
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At the heart of the crisis US household behaviour
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World growth slowing dramatically, and all in it
together
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Trade (key motor of LA growth) slows
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Global industrial activity and international
trade hit hard
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And commodity prices collapse
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Official interest rates fall to zero ...
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... but cost of investment capital rises
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Emerging market bond spreads reflect risk
aversion and contagion
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So capital flows slow down, and may even reverse
in 2009leading to major debt crises
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so debt default risk rises
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The world economy could fall into recession in
2009
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And commodity markets will take a long time to
recover
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The Impact on Latin America
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Facing the gathering storm (IDB, 28 December
2008)

• The past six years have been among the most
  glorious for Latin Americas once-fickle
  economies. Growth was fed by soaring commodity
  prices and generally more cautious fiscal
  policies. Almost 40 million individuals were
  swept above the poverty line.
• As the effects of the financial crisis in the
  United States and Europe deepen, Latin America
  and the Caribbean is bracing for the storm. Raw
  material prices are sharply lower and government
  budgets are tested.
• Growth in the region will likely to slow to
  between 2 percent and 2.5 percent in 2009 from
  4.5 percent a year earlier. Capital flows into
  the region are likely to fall below the required
  250 billion. Millions may be pushed back into
  poverty again.

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Risk premium rises again, as foreign investors
become more risk-averse
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Major forced devaluations in the leading regional
economies ...
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...lead to major real exchange rate depreciation,
and thus real wage decline
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La región continúa volando, pero como un
planeador. Los motores del crecimiento se han
apagado(Alicia Bárcena, Secretaria Ejecutiva,
CEPAL Santiago, 18 de diciembre de 2008)
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Economic policies in the region designed to be
counter-cyclical once more
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All the governments in the region have taken
expansionary and intervention measures
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Monetary measures have limited impact in
recession (pushing on a string JMK) fiscal
multipliers are stronger
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Policy response - 1

• Rapid reaction to export decline (both volume and
  price) and capital outflow. Output, employment,
  consumption and investment all falling. 
• Although macroeconomic strength (fiscal balance,
  low inflation, high reserves) greater than in
  previous crises. These fundamentals do not make
  LA immune or decoupled but do give more policy
  space for counter-cyclical policies initially
  monetary but increasingly fiscal in nature.
•  Retreat from fixed rules or autonomous policy
  bodies governments become more active. But scope
  for fiscal impulse (e.g. through public works)
  constrained by the balance of payments.
•  

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Policy response - 2

• Monetary policy to maintain bank liquidity to
  producers is crucial, and more rapid than fiscal
  measures (tax reductions or expenditure
  increases). 
• Effectiveness of monetary policy depends on depth
  and sophistication of financial markets and
  credibility of monetary authorities. Smaller
  countries or weak states have real problems. 
• Fiscal expenditure increases have more impact
  than tax cuts, which can lead to higher saving
  possibly abroad (i.e. capital flight). Direct
  transfers more effective than new government
  programmes, but hard to administer.

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Policy response - 3

• Public investment has little employment impact
  unless by design (e.g. rural roads) decades of
  budget constraint minimized the project
  portfolio. Tax reductions last resort. 
• South American countries much more proactive in
  countercyclical measures than Central America and
  the Caribbean.
• Support from IFIs has been small most of their
  effort is bailing out Eastern Europe

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Longer-term consequences?

• Hard won gains since 1995 crisis (fiscal
  balance, exchange reserves, low inflation,
  exchange rate stability, sound banking) may all
  be lost.
• Much depends on the speed of recovery of (a) the
  US economy and (b) commodity prices. Five years
  at least for both.
• Growing doubts about the neo-liberal economic
  development model, but nothing to replace it
  (yet).

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Some recent sources

• ECLAC/CEPAL La reacción de los gobiernos de
  América Latina y el Caribe frente a la crisis
  internacional. Santiago Feb 2009
• IMF World Economic Outlook Update (Washington,
  Jan 2009)
• World Bank GLOBAL FINANCIAL CRISIS AND
  IMPLICATIONS FOR DEVELOPING COUNTRIES (G-20
  Finance Ministers Meeting, São Paulo, Brazil
  November 8, 2008)
• IDB Facing the gathering storm (Washington Dec
  31, 2008)
• Balance Preliminar de las Economías de América
  Latina y el Caribe 2008 CEPAL santiago jan 2009
• Group of Twenty Meeting of the Deputies January
  31February 1, 2009 London, U.K. (Note by the
  Staff of the International Monetary Fund)
• World Economic Situation and Prospects 2009
  United Nations, New York, January 2009