Macroeconomic volatility in Latin America: a view and three case studies

Abstract

After decades of trial, error, and occasional regress, the pieces of a successful Latin American economic model can be seen scattered among the leading economies of the region. The most traditional macroeconomic maladies of the emerging world –such as chronic fiscal imbalances and monetary gimmicks– are gradually being left behind. Many of these economies have made significant progress in their regulatory and supervisory frameworks and, at times, have been leaders beyond Latin American boundaries in allowing private sector coparticipation in a wide array of ex-public sector activities. Despite these significant efforts, several structural sources of volatility remain, and new ones have emerged as a result of the new and otherwise better economic environment. Chile offers a concrete example, having experienced a sudden and sharp recession during the recent global turmoil after a decade of solid performance. This setback raised concerns not only to Chileans but also to regional policymakers accustomed to see in Chile’s stability the eventual reward of their reformist efforts. However we have learned repeatedly that the reward for successful reforms may not come in the form of a dramatic decline in economic fluctuations, at least in the short to medium run. As Asia has recently shown, an advanced developing economy is still fragile. The fast pace required by dynamic growth and restructuring, unbalanced development across different institutions and markets, and still-limited range of precautionary options make for a delicate and potentially volatile scenario. The main goal of this paper isto identify some of these imbalances, and to hint at policy considerations raised by these. While emerging economies suffer from multiple problems, I have pursued a minimalist and parsimonious account of volatility, highlighting that which is relatively new and focusing on countries that have already attenuated most of the traditional sources of macroeconomic instability in Latin America. The paper is based on three case studies –Argentina, Chile and Mexico– whose combined experiences illustrate the most central dilemmas faced by emerging economies. While embodied differently in each country, there are clearly two main common factors behind structural volatility: (a) weak international financial links, and (b) a still limited development of domestic financial markets, particularly for medium and small size firms. Once interacting, these two ingredients not only create volatility but they also generate externalities that require policy intervention. Most other shocks and deficiencies are leveraged –even made possible– by these two factors, and to the frustration of highly competent policymakers, the environment becomes intolerant of policy mistakes. Each of these countries experience is sufficiently different to identify these interactions between the core ingredients and more traditional factors. Some of these interactions include: (a) the exchange rate system and monetary credibility, (b) fiscal imbalances, (c) a fragile banking system, (d) labor market rigidities, and (e) an inadequate –in the sense of lack of contingency– central bank mandate. The paper is organized in three parts. Section II sketches the basic view, outlining the main line of argument with a simple model. The second and main part summarizes each country’s recent experience with real volatility while establishing connections to the core ingredients discussed above. The main policy lessons are finally extracted in Section IV.