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Reducing exposure to financial crises

Three measures that countries in Latin America and the Caribbean could take to reduce their exposure to financial crises were highlighted by economist John Williamson in a recent presentation to the board of executive directors of the Inter-American Development Bank.

Countries in the region should consciously aim to make their fiscal policies counter-cyclical as the first measure to reduce the risks of a financial crisis, stated Williamson, a senior fellow at the Institute for International Economics in Washington, D.C.

The second measure would be for governments to use an encaje (minimum reserve requirement) or a tax to limit foreign borrowing by the private sector during booms. And, in the third place, he stated, governments should aim to curtail and ultimately eliminate the use of international loans denominated in foreign currencies.

Williamson, who coined the expression “Washington consensus” for the set of market-oriented macroeconomic policies advocated by the multilateral organizations for Latin America in the early 1990s, also stressed the potential role of the IDB in aiding those measures.

In terms of stimulating counter-cyclical policies, Williamson said the IDB might consider supporting this process by providing a venue for peer monitoring of rules designed to secure that outcome.

In regards to an encaje or a tax to limit foreign borrowing by the private sector during booms, Williamson proposed that the IDB might provide a forum for a preliminary international discussion of whether the international community should preserve the use of this policy tool.

As to the third measure, Williamson stressed that a good start would be to transform loans from multilateral organizations, as proposed by Harvard professor Ricardo Hausmann. In a presentation to the IDB board of executive directors in June 2003, Hausmann recommended that borrowing countries acquire debt indexed in a pool of domestic currencies, and that multilateral banks should begin issuing debt in these currency pools. Governments should also progressively switch their sovereign borrowing in this same fashion, added Williamson, and they might offer a tax incentive for the private sector to follow suit.

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