Allow me to begin by thanking our host, Mr. Alan Greenspan, and his institution, the Federal Reserve Board of the United States, for their hospitality. I would especially like to thank Alan, as a good friend of Latin America and the Caribbean, for the interest and support he has always shown for the region.
I would also like to extend a special greeting to the Center for Latin American Monetary Studies (CEMLA) in the person of its Director-General, Mr. Kenneth Coates, and all its staff who are here with us today. My greeting goes out on behalf of the IDB, which has enjoyed a long-standing relationship of dialogue and cooperation with the Center. Over the years, the Center has welcomed many outstanding figures from our region, such as Mr. Javier Márquez, who served our institution for many years.
CEMLA has long been a meeting point for central banks but, above all, it is a center for research and technical training to which we are all greatly indebted, especially those of us who have had the honor to be part of the family of central banks and share the friendship of the distinguished personalities of that milieu.
If we step back and look at our region’s assets and liabilities, it is clear how central bank management in recent years has taken on growing responsibility with a high level of professionalism and independence. As a result, today we enjoy levels of stability that represent a valuable achievement among our arduous but necessary efforts to ensure solid fundamentals for our economies. CEMLA has made an important contribution enabling these institutions to advance along the lengthy path to institutional maturity and responsible management.
I would like to focus my comments here today on an issue that has been growing in significance over recent years but takes on special relevance in the circumstances that today define our region. That issue is whether there is a need for macroeconomic coordination in Latin America and, if so, what the objectives and instruments of that coordination should be.
Before answering the first of those questions, we need to ask ourselves: when is it advisable to coordinate macroeconomic policies among countries? One might say that it is when the economic decisions of one country seriously affect another country. Is this precisely the case in Latin America today?
The initial reaction would appear to be negative. Even though trade interdependence among the countries of Latin America and the Caribbean has grown over the past few years, trade relations continue to be modest. At the same time, financial interdependence between groups of countries in the region remains weak as a result of the low volume of intraregional financial transactions; also, membership in a regional group has not created strong channels for clear financial contagion from one country to another. A recent exception here is Uruguay, given its close links with the financial markets of Argentina.
However, the reaction is quite different if macroeconomic coordination is viewed as a tool for regional integration or as part of a forward-looking vision of economic cooperation among countries that share a common history, values, geography, and financial and economic relations with great capacity for deepening. In those circumstances such coordination is both necessary and timely in moments of financial turmoil and crisis.
Within the context of such a vision, what role can macroeconomic coordination play in the region today?
During the 1990s, the countries of Latin America and the Caribbean posted significant advances in the area of macroeconomic stability and a number of structural reforms aimed at achieving better allocation of resources. Although some of the reforms fell short of their targets and some pockets of macroeconomic disequilibrium continued to exist, the situation had improved substantially.
Despite this, the region has not been able to make a return to reasonable levels of growth. In recent years, several countries have witnessed a reappearance of macroeconomic instability and stagnation – or even drops – in production. Part of the problem undoubtedly stems from incomplete reforms and inappropriate economic policies, which in many cases were incompatible with the exchange-rate regimes adopted. The deterioration in the region’s economic situation can also be traced to the external shocks triggered by the sharp drop-off in capital flows as a consequence of financial and exchange-rate crises elsewhere in the world. Given the inherent nature of the large-scale development of capital markets in recent years, the magnitude and characteristics of the shock were similar to those that shook the region in the early 1980s. In any event, in one way or another the instability of some countries has had a contagion effect on others, and the stagnation and instability of the beginning years of this decade are reminiscent of times that the region seemed to have left behind.
During the 1980s and early 1990s, Europe too experienced instability and contagion—although to a lesser degree than in our region. The response was to deepen the integration process and, especially, macroeconomic coordination, which ultimately led to the adoption of a single currency.
The lesson learned from this valuable experience would seem to indicate that macroeconomic coordination is appropriate for our region at the current juncture and for the foreseeable future.
The following five questions provide a starting point for the debate:
What form should this coordination take?
Is such coordination possible today?
What would be the real costs of this coordination for countries that engage in it?
What incentives could be mobilized to foster this coordination?
How could exchange-policy coordination be included in this objective?
Here are some brief answers to those questions.
What form should this coordination take?
Giving thought to the appropriateness of such coordination raises the parallel question of what kind of coordination would be best suited to the region. Leaving aside for a moment the matter of adopting a single currency, we feel that coordination should focus on two key issues: macroeconomic convergence, and institutional reforms to ensure the sustainability of the convergence process. Macroeconomic convergence should seek to set specific limits for fiscal deficit, public indebtedness and inflation. Bearing in mind the region’s vulnerability, fiscal deficit and debt levels need to be lower than those set in the European Union, and based on European experience, the fiscal imbalance to be targeted should not be current deficit but rather structural deficit. Considering our region’s exposure to external shocks, setting limits for the current-account deficit and short-term external borrowings seems to be an appropriate path. If the process of convergence is to be sustainable over time, it is both advisable and necessary to implement a number of reforms, such as central bank autonomy, a new institutional structure governing the relationship between the national and provincial governments, and adequate regulation and supervision of the financial system. These reforms should not be viewed as substitutes for but rather complements to the blueprint for convergence.
An agreement on coordination should pursue two objectives. First, it should reduce instability in the region and, second, it should allow for deepening of the integration process, since it would provide an incentive to reach agreement with the "responsible partner" rather than isolate the partner that is experiencing difficulties. Both objectives must necessarily be shared by all countries in the region. Stability is a "public good", and as such it is important not just for the country that obtains it but for the entire region as well. Trade and financial integration of the subregions is a shared idea of the various countries and it will undoubtedly boost growth capacity for the region as a whole. Accordingly, to the extent that coordination reduces instability and allows deepening of the integration process, the only possible answer as to the advisability of moving forwards with macroeconomic coordination arrangements is in the affirmative.
Is such coordination possible today?
As to the actual possibility of moving ahead with this process, the answer is a bit more complex. First, the incentives will need to be strong enough to keep countries committed in different circumstances. In Europe, the incentives were based on: losing face if they did not participate in the process; strong trade interrelationships, which threw a very negative light on any given partner’s instability (especially with exchange rates); and economic and political sanctions for not meeting targets – sanctions imposed respectively by the markets and by the citizenry of each country. These factors are not necessarily present in our region. Although trade relationships have grown significantly, none of our subregional agreements is equivalent to even one third of the relationship existing in Europe in the early 1990s; there is no "reputation cost" for failure to comply with a regional-level agreement; and – partly because of the foregoing but also because the agreements are not sufficiently transparent – there are no sanctions for failure to abide by the agreements.
Even so, despite the need for greater trade interdependence and elimination of all protectionist measures within the framework of integration agreements, there is a significant degree of financial interdependence, and this is what engendered the recent contagion problems. Consequently, instability of any given partner is clearly a problem and it is one that macroeconomic coordination could help to mitigate. Although the temptation to abandon a partner experiencing difficulties is something that all countries have felt on more than one occasion, experience shows that this does not necessarily eliminate the contagion, especially in the presence of close commercial ties. Similarly, the region’s various integration agreements seek to deepen interdependence, so over time this aspect would be expected to increase and that needs to be taken into account. Lastly, setting regional targets would increase the possibilities of achieving greater internal discipline in each of the countries, which would clearly be a positive incentive for the governments of the region. In this regard, it is worth noting that the macroeconomic constraints created by a regional agreement in which the countries have a significant presence could generate more positive reactions than if they were viewed as being imposed "from outside".
What would be the real costs of this coordination?
The benefits of coordination need also to be compared with the process’s associated costs, specifically the decreased autonomy of countries to set their own economic policy. The perception of a very high cost in this area is based on the assumption, first, that all countries are able to manage economic-policy instruments adeptly and, second, that coordination necessarily means complying with rules and criteria that greatly limit the freedom of economic and political authorities. Experience shows, however, that the leeway for economic policy action has shrunk considerably in recent times, and the kind of coordination we are proposing cannot be construed as eliminating this leeway for national authorities. That is, unless someone is against setting reasonable targets for fiscal disequilibrium and inflation. Or someone is against creating an institutional structure that fosters stability of the financial system (financial regulation and supervision) and controlling inflation (central bank autonomy).
What incentives could be mobilized to foster this coordination?
In any event (and our assessment aside), bearing in mind that experience has shown that national authorities often perceive the costs of coordination to be greater than its benefits, efforts must be undertaken to create incentives that underscore the benefits of coordination. Several avenues of action are possible.
a. First, multilateral agencies, especially the IDB, could move ahead with programs to support the necessary structural reforms for macroeconomic coordination and all other kinds of reforms that foster interdependence among the countries and, by extension, boost demand for coordination.
b. Second, we need an institutional framework that makes such agreements more transparent, coupled with pressure exerted by the citizenry and markets on the governments. To achieve this, there would not be any need for a superstructure: simply an institutional presence with sufficient relative weight; for instance, a team of macroeconomic experts to advise and evaluate outcomes and, above all, enhance the transparency and credibility of the process. Given its history and record in the region, the Center for Latin American Monetary Studies (CEMLA) would be an ideal candidate to handle this issue.
c. Third, we need to step up contacts among the region’s political leaders, because only through dialogue and mutual trust will it be possible to make gradual yet permanent headway. CEMLA, the Economic Commission for Latin America and the Caribbean (ECLAC) and the IDB could work together in this area. The IDB has already gained some experience in this area through the Regional Policy Dialogues it has launched on various topics, thus fostering communication among the region’s policy-makers.
Naturally, there is no substitute for political will, without which all of what I have said here is mere entelechy. We are convinced, however, that there is genuine political will in the region to deepen interdependence and reduce volatility, and so it makes sense to forge ahead with macroeconomic cooperation.
- How could exchange-policy coordination be included in this objective?
A few words also need to be said about coordination of exchange-rate policies. Theory and experience have both shown that highly unstable exchange rates within the framework of integration agreements lead to economic and political problems. Devaluation of one partner’s currency, often the result of a prior unsustainable appreciation, is seen as opportunistic behavior and triggers protectionist reactions and political complications that conspire against the integration process. That was one of the main reasons for the European Union’s adoption of a single currency. However, this does not appear to be a viable option for the region (today at least), given the current diversity of exchange-rate regimes – which range from dollarization to fully floating – and the absence of a sufficiently strong currency, such as the German mark. Still, if at some point it becomes advisable to adopt a single currency under one or all of the region’s integration agreements, this would be an outcome of many years of macroeconomic convergence and an irrefutable show of political will by the countries in support of the process. This leaves us with the problem of exchange-rate instability and its impact on integration and macroeconomic coordination. Little can be done in this area, aside from the certainty that some degree of macroeconomic convergence would help to reduce exchange-rate volatility in the region. In this context as well, the differences among external shocks and the existence of various exchange-rate regimes indicate that considerable volatility will continue to exist. The debate remains open as to the advisability – in cases where there are seemingly excessive fluctuations in relative prices under integration agreements – of putting automatic mechanisms in place to offset this phenomenon, thus averting the political and economic problems mentioned earlier. To be sure, this is a controversial issue and one that would be complicated to implement, but it needs to be included in the technical debate.
Two closing comments. First, if the countries are resolved to move ahead with subregional integration agreements, then the multilateral financing agencies need to support – or at least respect – that reality. Accordingly, the design or recommendations for policies at the national level need to be evaluated from a regional standpoint.
Lastly, a comment on the nature and magnitude of external shocks. If the countries of the region continue to experience shocks such as those of the past few years, not only will it be difficult to coordinate macroeconomic policies, but it will also be difficult to maintain stability and growth. Consequently, we need to give thought to another kind of coordination, one that should complement the type of coordination we have been discussing here. I am talking about coordination to set up international – and also regional – compensatory mechanisms that will allow us to endure external shocks in a way that disrupts growth as little as possible. This topic, however, has been the subject of broad debate and is one that we will surely be able to revisit the next time we meet.