Download Financial crisis in Latin America

The Argentinean and Chilean experience
Pre-crisis developments
• Low interest rates in the United States in the early
1990s certainly provided an initial impetus to
renewed capital flows.
Pre-crisis developments
• Low interest rates in the United States in the early
1990s certainly provided an initial impetus to
renewed capital flows.
• Because the developing world had extensive dollardenominated debts (original sin in action), there was
an immediate and spectacular rise in the interest
burden debtor countries had to pay.
• Sharp increase in the value of the dollar in the
international market.
American Dollar Exchange Rate Index
108
106
104
102
100
98
96
94
92
90
Real effective
exchange rate index
(2000 = 100)
Pre-crisis developments
• Low interest rates in the United States in the early
1990s certainly provided an initial impetus to
renewed capital flows.
• Because the developing world had extensive dollardenominated debts (original sin in action), there was
an immediate and spectacular rise in the interest
burden debtor countries had to pay.
• Sharp increase in the value of the dollar in the
international market.
• Finally, primary commodity prices collapsed,
depressing the terms of trade of many poor countries.
Argentina
Convertibility Law (April 1991)
 Motivated by previous decade of financial instability
and even hyperinflation.
 Made Argentina’s currency fully convertible into U.S.
dollars at a fixed rate exactly one peso per dollar.
 Required that the monetary base be backed entirely by
gold or foreign currency, so in one stroke it sharply
curtailed the central bank’s ability to finance
government deficits through continuing money
creation.
Intended and unintended
consequences
 Argentina’s plan had a dramatic effect on inflation,
which remained low after dropping from 800 percent
in 1990 to well under 5 percent by 1995.
 A real appreciation of the Argentinean Peso (30% from
1990 to 1995) led to unemployment and a growing
account deficit.
 In the mid-1990s the peso’s real appreciation process
ended, but unemployment remained high because of
rigidities in labor markets.
Argentinean Annual Inflation Rate
3500
3000
2500
2000
1500
1000
500
0
Inflation, consumer prices
(annual %)
2001 Argentinean Financial Crisis
 As the world economy slipped into recession in 2001,
Argentina’s foreign credit dried up.
 The country defaulted on its debts in December 2001
and abandoned the peso-dollar peg in January 2002.
 The Peso depreciated sharply and inflation soared
once again. In a daring move, the government
defaulted on Argentina’s external debt. That action
was actually followed by strong economic growth.
Argentina
350
300
250
GNI (current US$)
200
150
100
50
0
External debt stocks,
long-term (DOD,
current US$)
Chile
Monetary Developments
 Chile instituted a tough regulatory environment for
domestic financial institutions and removed an
explicit bailout guarantee that had helped to worsen
Chile’s earlier debt crisis.
 A crawling peg type of exchange rate regime was used
to bring inflation down gradually, but the system was
operated flexibly to avoid extreme real appreciation.
 The Chilean central bank was made independent of
the fiscal authorities in 1990. That action further
solidified the commitment not to monetize
government deficits.
Chilean Peso Exchange Rate Index
120
115
110
105
100
95
90
85
80
Real effective exchange
rate index (2000 = 100)
Capital Inflows Policy
 All capital inflows had to be accompanied by a one-
year, non-interest-bearing deposit equal to as much as
30 percent of the transaction.
 Penalty felt disproportionally fell on short-term
inflows.
 One motivation for the implied capital inflow tax was
to limit real currency appreciation; the other was to
reduce the risk that sudden withdrawal of short-term
funds would provoke a financial crisis.
Chile
30
25
20
15
10
5
0
GDP growth (annual
%)
Inflation, consumer
prices (annual %)