Download why can`t we afford counter

Towards effective social
insurance in Latin America:
why can’t we afford countercyclical fiscal policy?
Comment by
Ricardo Hausmann
Harvard University
The problem
•
•
•
•
•
Latin America is very volatile
People suffer from this
Fiscal policy is pro-cyclical
…aggravating volatility
…and lowering social protection when it is
most needed
Proposed solution
• Increase automatic stabilizers
– Pre-commit to spend more in bad times
• Improve savings in good times
– Fiscal rules and stabilization funds
• Improve creditworthiness during bad times
– GDP-indexed bonds
What causes pro-cyclicality?
• Excessive spending and borrowing in good
times limits creditworthiness in bad times
– Hausmann, Gavin, Perotti and Talvi (1996),
Talvi and Vegh (2000)
• Solution: behave more prudently in good
times so you can still borrow in bad times
– Ergo: Fiscal institutions and rules
• Is this correct?
An alternative interpretation
• Debt service is highly anti-cyclical
• …because debt is denominated in US$
– In good times, the real exchange rate is strong, making
US$ debt cheap
• ..or in short term in pesos
– Real interest rates go up in bad times, as the
government attempts to avoid further real depreciation
• Hence, procyclicality is a consequence of original
sin
Real GDP growth is more
volatile
Real GDP volatility
Industrial Developing
2.0%
4.7%
LAC
4.5%
But not that much to write home about
…but GDP measured in US$ is 9
times more volatile
Real GDP volatility
US$ GDP volatility
Industrial Developing
2.0%
4.7%
14.0%
27.5%
LAC
4.5%
36.2%
This is the relevant measure if you borrow in US$
…movements of exchange rates
are large and persistent
Industrial Developing
Real GDP volatility
2.0%
4.7%
US$ GDP volatility
14.0%
27.5%
Gap in RER 5-y MA
19.7%
84.5%
LAC
4.5%
36.2%
91.8%
This is the maximum gap between 5-year
Moving average of the real exchange rate
Dollar GDP tends to collapse at
times of crises
Year
Country
Chile
Chile
Costa Rica
Dominican Republic
Ecuador
Guatemala
Guyana
Honduras
Jamaica
Jamaica
Jamaica
Mexico
Mexico
Mexico
Paraguay
Uruguay
Venezuela
Venezuela
Average
1973
1982
1981
1985
1999
1986
1987
1990
1978
1983
1991
1976
1982
1994
1989
1982
1986
1989
Growth
Growth
US$ GDP Real GDP
-69.3%
-4.9%
-38.0%
-10.3%
-70.3%
-2.3%
-49.7%
1.0%
-50.2%
-7.3%
-44.8%
0.1%
-35.1%
0.9%
-56.3%
0.1%
-36.1%
0.6%
-38.1%
2.3%
-46.4%
0.7%
-40.6%
4.4%
-54.4%
-0.6%
-35.2%
4.4%
-39.5%
5.8%
-66.0%
-9.8%
-47.0%
6.5%
-43.8%
-8.6%
-47.8%
-0.9%
Declines in US$
GDP greater than
-35%
Notice that capacity
to pay in US$
collapses more than
real GDP
Implications
• The capacity to pay dollar-denominated debt is
dependent on the market value of GDP in US$
• But this measure is 9 times more volatile than real
GDP
• …and collapses in bad times
• This is associated with large and persistent
cyclical movements in the RER
• The problem may not be that we borrow too much
in good times, but that we borrow too poorly
Credit ratings are low, considering
that debt levels are low
19
Austria
UnitedUnited
K SGermany
Japan
Norway
Finland
Sweden
Denmark
Australi
Spain
Belgium
Canada
Italy
rating for long-term foreign cur
Iceland
Slovenia
Cyprus
Greece
Israel
Czech
Chile Re
Estonia
Hungary
Poland
Latvia
China
Tunisia
Oman
Slovak R
El Salva
Mexico
Panama
Costa Ri
Argentin
Brazil
Turkey
Dominica
India
Morocco
Jordan
Paraguay
Pakistan
4
-.430356
1.04646
de_gdp2
…even considering the lower tax
base
Norway
Finland
rating for long-term foreign cur
19
S
Austria
Germany
United
KUnited
Japan
Sweden Denmark
Australi
Spain
CanadaBelgium
Italy
Iceland
Slovenia
Cyprus
IsraelGreece
Czech Re
Hungary
Estonia
Poland
Latvia
China
Tunisia
Mexico
Panama
Costa Ri
Dominica
Paraguay
4
-.772123
Argentin
Brazil Turkey
Morocco
Jordan
India
Pakistan
de_re2
5.49817
Would domestic peso debt be
safer?
Short term real interest rates are
very volatile and rise in bad times
(monthly data, 1990-1999)
United States
Latin America
Mexico
Venezuela
Brazil
Ecuador
Uruguay
Peru
Colombia
Chile
Costa Rica
Argentina
Panama
Volatility elasticity
0.9
-3.3
10.5
-126.3
23.0
-73.3
17.6
0.1
17.2
-451.6
12.2
-2.4
11.8
2.6
11.2
-151.4
7.8
-16.6
5.4
-8.8
5.0
-19.7
4.0
-221.9
0.6
-0.4
t-stat
-4.1
-10.9
-13.2
0.0
-3.4
-0.5
0.4
-1.7
-2.3
-1.0
-5.0
-10.3
-0.6
Some consequences
• Domestic currency short-term or floating rate debt
may be subject to large increases in nominal
interest rates, especially in bad times
• This also makes debt service pro-cyclical
• Volatility of the short rate limits the extension of
maturity
• Under these conditions, US$ borrowing may be
safer
– Hausmann and Chamon (2002) argue that this may
generate multiple equilibria in monetary policy and
debt denomination
Original sin and the limits to
anticylical fiscal policies
• If there is a SIGNIFICANT NET foreign debt (public or
private)
• …and it is in foreign currency
• Exchange rate movements cause aggregate wealth effects
– Depreciations lower real income
• Makes debt service harder…
• …lowering creditworthiness in bad times
– Less access to finance in bad times
• Makes governments forced to tighten fiscal policy, unless
it wants to aggravate crowding out
• …and tighten monetary policy to avoid further
depreciation
Implication: automatic stabilizers
• If the problem is that debt service increases in bad
times, due to debt denomination,
• …then the solution is NOT to pre-commit to
increase spending in bad times
• “Increase automatic stabilizers” NOT YET
• This will only aggravate the collapse in solvency
in bad times and will force to cut other
(presumably good) but a-cyclical social programs
such as Education and Health
Implication: debt structure
• Work on debt structure first
• Ideal is long-term, fixed rate peso-denominated
bonds
– They change in value with the real exchange rate, and
with inflation
– But they are the hardest to achieve
• The paper recommends GDP-linked bonds
– GDP is very hard to credibly measure
• It may be much easier to develop long-term
inflation-indexed fixed rate debt
– Protects against collapses in RER & US$ GDP
– As in Chile (is this part of Chile’s secret?)
1
0.9
OS is the consequence of the currency
concentration of the global portfolio (0.9857)
Debt by
Currency
0.8
Debt by Country
(0.8859)
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
United States
EUROLAND
Japan
U.K
Switzerland
Canada
Australia
Implication: international agenda
• It needs an international solution
• Create liquidity for instruments with EM
currency risk but no credit or country risk
– IFIs could play a large role
• This would allow IFIs to lend in local
currency
• Develop the swap market to undo the
currency mismatch of EMs
Implication: fiscal rules
• If the problem is debt structure, fiscal rules should
deal with this
• Currently, rules relate to deficits and spending
• Nothing is geared to monitor the risks involved in
the debt structure
• Alternative: target a risk-weighted level of debt
– Risk weights should reflect the pro-cyclicality and
volatility of debt service
– Allows the political system to internalize the difference
between cheap borrowing and safe borrowing
Conclusion
• It would be great if the government could offer
social protection against aggregate shocks
• …but before committing to do so, it needs to be
able to do so
• At present, many countries are unable to protect in
bad times and in fact need to impoverish their
populations in bad times to avoid greater damage
• We should develop the ability to protect before we
commit to use it