Download Policy Responses to Sudden Stops - Inter

POLICY RESPONSES TO
SUDDEN STOPS:
INITIAL CONDITIONS AND
POLICY CHOICES
Eduardo Cavallo & Alejandro Izquierdo
IADB
XXVI Meeting of the Latin American Network of
Central Banks and Finance Ministries
October 17, 2007
Macroeconomic Vulnerability: Twin Deficits
Fiscal Balance
External Position
Overall Balance*
Current Account
Int. Reserves
% of GDP, last 4 quarters
% of GDP, last 4 quarters
% of GDP, end of quarter
1998.II
1998.II
1998.II
Argentina
-1.2%
-4.7%
7.7%
Brazil
-6.1%***
-3.6%
8.1%
1.3%
-6.5%
19.1%
Colombia
-3.0%
-6.1%
8.7%
Ecuador
-4.6%
-3.0%**
8.0%
Mexico
0.7%***
-5.8%***
6.2%***
Peru
-1.2%
-6.9%
17.6%
Uruguay
-0.9%
-1.8%
10.4%
Average
-1.9%
-4.8%
10.8%
Chile
* Fiscal Accounts Definitions. Argentina: National Administration, Public Enterprises and Other Public Entities; Brazil: General Government; Chile: Central
Government; Colombia: National Central Government and Non Financial Public Entities; Ecuador: Central Government, Public Entities and Non Financial Public
Enterprises Mexico: Federal Government, Public Entities and Public Enterprises; Peru: Central Government; Uruguay: Non Financial Public Sector and Central Bank
Venezuela: Central Government;
** 1997.IV Data; *** 1993. IV Data
The Sudden Stop Specter:
Domestic Liability Dollarization (DLD and Net DLD)
• Sudden Stop brings about substantial change in relative
prices (Calvo, Izquierdo and Talvi, 2003)
• DLD as share of GDP proxies for size of burden
The Sudden Stop Specter:
Balance-Sheet Effect and Drops in Output
• The outliers: Peru and Mexico
The Sudden Stop Specter:
Balance-Sheet Effect and Drops in Output
Without US
Mega-Package?
• PER
• Netting out Reserves
The Sudden Stop Specter:
Balance-Sheet Effect and Drops in Output
Banking
Crises
• Standstill in payments system and output collapse
Restrictions on Monetary Policy:
DLD and Fear of Floating
• 3 and DLD: Reason to believe floating fears
were correct?
Temporary or Persistent Financial Drought?
75
Vodka was Stronger than Tequila in LAC
(Net private capital flows, US$ billion)
70
65
60
55
50
45
40
35
Tequila
T
Russia
T+1
T+2
T+3
• Tequila crisis was short lived. Would it be the same for
the Russian crisis?
What Policies Went Wrong Beyond Initial
Conditions? Colombia
Defense of the Exchange Band
• Low DLD
2100
60
50
• Coming from a history of relatively
high inflation (23.5% on average
for period 1990:1-1998:7)
• Sustaining ER regime with high
interest rates (as high as 31% in
real terms)
• Inflationary concerns (relatively
high 1 – inflation as low as 8.2%
in 1999)
• High ex-post real interest rates led
to banking crisis (particularly
mortgages)
1900
40
1700
30
20
1500
10
1300
0
Nominal Exchange Rate
Inter-bank Rate
What Policies Went Wrong Beyond Initial
Conditions? Argentina
• High DLD and closed economy
Argentina: Relative External Financial Conditions
(EMBI Arg - EMBI+)
• Temporary or persistent shock?
5,000
4,000
• High liquidity buffers, but large
vulnerability to balance sheet effects
under SS (both private and public)
3,000
2,000
1,000
Feb-02
Jun-01
Oct-01
Feb-01
Oct-00
Jun-00
Feb-00
Jun-99
Oct-99
Oct-98
Feb-99
Jun-98
Jun-97
28,000
7,000
26,000
6,000
24,000
5,000
22,000
4,000
20,000
3,000
18,000
Foreign R eserves
M onetary Liabilities
Net D omestic Credit
16,000
2,000
1,000
14,000
Jan-02
Nov-01
Sep-01
Jul-01
May-01
Mar-01
Jan-01
Nov-00
Sep-00
-1,000
Jul-00
10,000
May-00
0
Mar-00
12,000
Jan-00
Million Pesos
• Step devaluation in 2002 was
inconsistent with banking crisis
resolution, wreaking havoc over
monetary aggregates
Increase in Domestic Credit and
Foreign Reserves Loss
Million Pesos - Net DC
• Interpretation of a need for liquidity
expansion in a context of insolvency
(particularly after “mega-exchange”)
accelerated collapse
-1,000
Feb-98
• Expected RER depreciation indicated
fiscal insolvency (politically feasible
flow adjustments would not offset
expected stock effect)
Oct-97
0
What Policies Went Wrong Beyond Initial
Conditions? Uruguay
• High DLD and closed economy
• Large trade and financial links to Argentina
(68% of dollar deposits held by foreigners)
• Temporary vs. persistent shock dilemma
and liquidity vs. balance-sheet effects
• After easening in 1999, fiscal tightening in
2000-01. A loosing battle when solvency
effects kick in: interest rate increases
offset other savings (deficit of 4.4% of
GDP by 2001)
• After bank run, intervention of domestic
banking system, leaving foreign banks
untouched (no “pesification”)
• Banking crisis resolution supported by
external package. Nevertheless, collapse of
GDP similar to that of Argentina.
• Counterfactual: Collapse would have been
bigger if crisis resolution had been different
(real effects from Argentina: 8% of GDP)
• Excessive debt: No room for fiscal policy
Haircuts on External Debt (%)
NPV Def. Conventional
Argentina
Ecuador
72.9
27.4
67
60
Uruguay
12.9
26.2
Source: Sturzenegger and Zettelmeyer (2005)
Macroeconomic Vulnerabilities: Then and Now
Fiscal Balance
External Position
International Reserves
Overall Balance*
Current Account
% of GDP, last 4 quarters
% of GDP, last 4 quarters % of GDP, end of quarter % of M2**, end of quarter
1998.II 2006.IV
1998.II 2007.I
Argentina
-1.2%
1.8%
-4.7%
3.5%
7.7%
16.6%
27.6%
54.4%
Brazil
-6.1%*** -3.1%
-3.6%
1.2%
8.1%
9.9%
22.5%
16.0%
Chile
1998.II 2007.I
1998.II 2007.I
1.3%
7.8%
-6.5%
4.8%
19.1%
10.3%
43.0%
19.7%
Colombia
-3.0%
-0.5%
-6.1%
-2.8%
8.7%
13.5%
29.1%
47.0%
Ecuador
-4.6%
3.3%
-3.0%*** 1.9%
8.0%
5.2%
35.2%
21.7%
Mexico
0.7%****
0.1%
-5.8%**** -0.6%
6.2%**** 8.2%
Peru
-1.2%
1.3%
-6.9%
2.8%
17.6%
19.0%
62.9%
67.6%
Uruguay
-0.9%
-1.0%
-1.8%
-1.8%
10.4%
17.3%
26.5%
34.5%
Average
-1.9%
1.2%
-4.8%
1.1%
10.8% 12.5%
21.4%****29.7%
33.5% 36.3%
* Fiscal Accounts Definitions. Argentina: National Administration, Public Enterprises and Other Public Entities; Brazil: General Government; Chile: Central Government;
Colombia: National Central Government and Non Financial Public Entities; Ecuador: Central Government, Public Entities and Non Financial Public Enterprises Mexico:
Federal Government, Public Entities and Public Enterprises; Peru: Central Government; Uruguay: Non Financial Public Sector and Central Bank Venezuela: Central
Government;
** M2 = Currency outside banks + demand deposits + time, savings and foreign currency deposits of resident sectors
*** 1997.IV Data; **** 1993. IV Data
Conclusions
• Keep dollarization specter away (on net terms)
• Use your instruments: Inflation concerns should not
dominate during Sudden Stop when instruments are
available and DLD is not at play
• Be on the lookout for changes in international cycles, not
just domestic cycles
• Contingent monetary policies?
• Public sector should be part of the solution, not part of the
problem
• Banking crisis resolution consistent with monetary policy
is a must
POLICY RESPONSES TO
SUDDEN STOPS:
INITIAL CONDITIONS AND
POLICY CHOICES
Eduardo Cavallo & Alejandro Izquierdo
IADB
XXVI Meeting of the Latin American Network of
Central Banks and Finance Ministries
October 17, 2007