Euro-Latin Network: The Macroeconomics Agenda Guillermo A. Calvo October 9, 2002.
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Transcript of Euro-Latin Network: The Macroeconomics Agenda Guillermo A. Calvo October 9, 2002.
Euro-Latin Network:The Macroeconomics Agenda
Guillermo A. CalvoOctober 9, 2002
The IssuesMoral vs. Globalization HazardSudden stops in capital flows:
Factors that contribute to vulnerabilityImplications in terms of real exchange rate adjustmentValuation effects on fiscal sustainability and financial
crises?Dollarization:
Additional vulnerability?Convergence or escape from domestic currencies?Can it be reversed?
The Issues (c’td)Banking:
Universal or Narrow Banking?Indexation in banking system and the choice of exchange
rate regime. Public debt management:
Optimal currency composition?Indexation mechanisms?
Inflation targeting:Effectiveness in dollarized economies?Credibility under large real exchange rate realignment
following sudden stops?
MORAL AND GLOBALIZATIONHAZARDS
Where The G7 Stand (?) G7 appear to hold the view that throwing liquidity into
BOP/financial crises is counterproductive Pontius Pilate’s Aproach to Crisis Prevention and
Resolution: Avoid BOP Crises: FLOAT
if applied to the domestic banking sector, this is equivalent to deposits being subject to floating, market-determined, prices.
problem: Fear of Floating (Terror of Floating in Argentina) Design Chapter 11 for Sovereigns
If applied to the domestic banking sector, this is equivalent to appealing to Chapter 11 even if banks are faced with a liquidity crisis.
problem: sovereigns stop repaying well before they become technically insolvent. Thus, this issue is eminently political.
The Moral Hazard View
Large bailouts starting with the Tequila $50 billion package, induced greater risk taking by governments and investors,
which increased the incidence of crises.
Moral Hazard: A Critique
Capital flows to EMs started to fall a year after Tequila
The composition of flows shifted in favor of Foreign Direct Investment
Private Net Capital FlowsEmerging Markets
-30
20
70
120
170
220
270
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
Financial globalization starts Tequila
Foreign Direct Investment
-50
0
50
100
150
200
250
300
1971
1973
1975
1977
1979 1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
Private Flows Private FDI
Financial globalization starts Tequila
Globalization Hazard ViewSince 1989 capital flows to EMs increased at a
very rapid rate, and also collapsed very sharply starting in 1996.
Volatility was high, and capital flow reversals reached record-high levels
Current account adjustments are much bigger in EMs than in Advanced Economies.
Crises could reflect institutional and informational features that apply especially to EMs.
KEY FEATURES OF EMs
SUDDEN STOPReversal of CapitalInflows (% of GDP)
Argentina 1982-83 20Ecuador 1995-96 19Mexico, 1981-83 12Korea 1996-97 11Thailand 1996-97 26Turkey 1993-94 10
Country/Episode
Source: Guillermo Calvo and Carmen Reinhart, (2000).
Fear of Floating: Probability of staying within narrow bands
+/-1 %band p/m
+/-2.5 %band p/m
US$/DM (2/73-4/99) 26.8 58.7Japan (2/73-4/99) 33.8 61.2Bolivia (9/85-12/97) 72.8 93.9Mexico (12/94-4/99) 34.6 63.5Peru (8/90-4/99) 45.2 71.4Uganda (1/92-4/99) 52.9 77.9
Source: Guillermo Calvo and Carmen Reinhart, “Fear of Floating,” QJE, (2002).
Exchange Rate
Fear of Floating: Probability of staying within narrow bands
+/-25 bpsband p/m
+/-50 bpsband p/m
US (2/73-4/99) 59.7 80.7Japan (2/73-4/99) 67.9 86.4Bolivia (9/85-12/97) 16.3 25.9Mexico (12/94-4/99) 5.7 9.4Peru (8/90-4/99) 24.8 32.3Uganda (1/92-4/99) 11.6 32.6
Source: Guillermo Calvo and Carmen Reinhart, “Fear of Floating,” QJE, (2002).
Nom. Interest Rate
10,00012,00014,00016,00018,00020,00022,00024,00026,00028,000
Jan-
96
Jul-
96
Jan-
97
Jul-
97Ja
n-98
Jul-
98
Jan-
99
Jul-
99
Jan-
00Ju
l-00
Jan-
01
Jul-
01
Jan-
02
Mill
ion
Peso
s
-1,000
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
Million Pesos
Cavallo Presses the Gas Pedal (Central Bank’s Balance Sheet)
Net Domestic Credit
Foreign Reserves
Monetary Liabilities
Cavallo is appointed
Source: Central Bank of Argentina.
CAPITAL FLIGHT IN LATIN AMERICA?
LAC-7 Business Cycle: 1997-2002(s.a. GDP, mean annualized quarterly growth rate)
Includes: Argentina Brazil, Chile, Colombia, Mexico, Peru and Venezuela
Deceleration Recession Recovery Stalling
-7%
-5%
-3%
-1%
1%
3%
5%
7%
9%19
97.I
1997
.III
1998
.I
1998
.III
1999
.I
1999
.III
2000
.I
2000
.III
2001
. I
2001
.III
2002
.I
LAC-7 Capital Flows(4 quarters, millions of US dollars and % of GDP )
Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela
0
20.000
40.000
60.000
80.000
100.000
120.00019
97-I
1997
-III
1998
-I
1998
-III
1999
-I
1999
-III
2000
-I
2000
-III
2001
-I
2001
-III
2002
-I
0%
1%
2%
3%
4%
5%
6%
% of GDP
Millions of US dollars
LAC-7 Business Cycle and Capital Flows (GDP and Non FDI Capital Flows, last four quarters)
-3%-2%-1%0%1%2%3%4%5%6%7%
Mar
-96
Sep-
96
Mar
-97
Sep-
97
Mar
-98
Sep-
98
Mar
-99
Sep-
99
Mar
-00
Sep-
00
Mar
-01
Sep-
01
Mar
-02
GD
P (y
oy %
cha
nge)
-4%
-3%
-2%
-1%
0%
1%
2%
Non
FD
I Cap
ital F
low
s (%
GD
P)
GDP
Non FDI Capital Flows
Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela
THE IMPACTOF SUDDEN STOPS
Sudden Stop
1998.II 2001.IIIReversalCapital Flows 5.6 1.6 -4.0
Non-FDI Capital Flows 2.0 -0.9 -2.9 FDI 3.6 2.5 -1.1
Note: Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru, andVenezuela. Source: Corresponding Central Banks.
Capital Flows, % of GDP
Equilibrium RERp
hs
p*
p**
p0
h
real trade factors
SS
P = PNT/PT
Liability Dollarization
ARG ECU COL BRA CHLB/e B* 0.08 0.02 0.59 1.76 1.30Y/e Y* 8.63 2.94 6.36 12.34 2.85
(B/e B*)/(Y/e Y*) 0.01 0.01 0.09 0.14 0.45
Source: Own estimates. Note: Values are given for 1998.
Public Sector Debt Mismatch Measure
Sudden Stop and Fiscal Adjustment: Argentina 1998 Debt to
GDPratio(%)
Req. Prim.SurplusAdjust.
(a) Baseline 36.5 0.3
(b) Change in Relative Prices to close the CA deficit (RER depreciation of 46,2%)
49.7 0.7
(c): (b) + 200 BPS Increase in Real Interest Rate
49.7 1.7
(d): (c) + 1% Reduction in GDP growth 49.7 2.2
(e): (d) + Contingent Liabilities 58.6 2.7
Source: Calvo, Izquierdo, Talvi (2002)
Note: The observed primary surplus for 1998 was 0.9 percent of GDP. The baseline scenario assumes a long run rate of growth of 3,8% and a 7,1% interest rate
9.3
22.6
32.8
35.6
44.5
NPV of Req. Adjust.
(% of GDP)
Vulnerability to Sudden StopsA small share of tradable goods output
relative to domestic absorption of tradable goods
Liability dollarization, both in government and non-tradable sectors
High initial public debt, denominated in foreign currency
Bank assets concentrated on government bonds and dollar credit to non-tradable sectors.
POLICY ISSUES
BAILOUT PACKAGESJustified under Globalization Hazard viewThe mid-1990s packages were successful
because capital flowed back very quickly (the prime example is Brazil in 1999).
At present, capital appears to be much slower to flow back, possibly due to Russia’s 1998 crisis and recent corporate scandals.
Thus, present packages may shield the financial but not the real sector, and recession could be large and long-lasting.
THE EXCHANGE RATE The current debate is between Fixed Exchange Rate
and Inflation Targeting. Inflation Targeting is equivalent to fixing the
currency to a basket of goods and services. Actually, if the basket contains only foreign
exchange, or the pass-through coefficient is very high, both systems would be equivalent.
Thus, the current debate is about the best basket to fix to. It is about fixing, not about floating.
Neither system ensures the existence of a Lender of Last Resort.
CHOOSING A BASKETNo basket prevents large exchange rate
misalignment. If the latter is a serious concern, one should adopt RER Targeting, which implies no nominal anchor!
The main focus should be on the financial system and, in particular, the prevailing type of indexation in the financial sector.
Thus, a highly dollarized system may call for full dollarization.
While, a UF system like in Chile, may call for UF targeting.
SUDDEN STOPLearn how to prevent it
Management of reserves and public debt Flexible financial system, contingent claims Flexible public prices and wages
And how to be ready if it happens Contingent credit lines Judicious use of reserves and credit lines to
bail out private sector and financial institutions, accompanied by dirty float.
Timely negotiation of debt restructuring.
Research DepartmentInter-American
Development Bank