Lessons from Latin American Economic Policy

Article excerpt

From the Latin American debt crisis, to the 1999 Brazilian currency crisis, Latin America has experienced serious fluctuation in its economy due to external political and economical factors. However, during the global financial downturn beginning in 2008, Latin America broke from this pattern. Though the region experienced a brief recession in 2009, the following year it began to project a 5.6 percent growth rate, significantly above the Organization for Economic Co-operation and Development's (OECD) average growth rate of 4.1 percent. This impressive growth rate, and the absence of a severe recession prevalent in much of the world, is the result of a series of financial maneuvers instituted throughout much of Latin America before the most recent economic crisis.

Diminishing Currency Mismatch

A primary reason for Latin America's resistance to the global economic downturn of 2008 was its handling of currency mismatch. Currency mismatch is created when a government bond issue is labeled in terms of a foreign currency, instantly creating higher costs for the borrower of the bond. For example, if an American company borrows funds from a Brazilian bank due to its low interest rates, the company would have to repay more money if the dollar had since weakened compared to the Brazilian real. The Argentine financial crisis of 2001-2002 is the best example of the above problem. However, in the 2000s, currency mismatch of some states within the hemisphere diminished dramatically, as noted by the reduced value of debt held in foreign currency.

During the 1990s financial crisis, economists around the world realized that high levels of debt held in foreign currency could potentially be the source of systemic damage. As a result, many Latin American states transferred their foreign-held debts into domestic currency. In fact, the region's total foreign debt was reduced from 40 percent in 2000 to below 20 percent in 2008. The exception to this was Brazil, who instead opened their market, thereby attracting international investments to boost the economy and pay the interest on debt. Additionally, growing bond markets and expanding foreign exchange reserves also contributed to an increase in assets held in foreign currency. The increasing asset which is denominated by foreign currency has helped to decrease currency mismatch. As a result, following the turmoil brought on by the global financial crisis, foreign reserves in Latin American countries sharply increased to $553 billion USD from a more modest figure of $86 billion USD.

Flexible exchange rate system

Also promoting economic growth in Latin America was the waning exposure to external factors. The decrease in vulnerability has, in part, been caused by the changes in the exchange rate system. A primary cause of the financial crisis in the late 1990s was the rigid exchange rate system that developed during this period. In the early 1990s, the region, including Brazil, implemented a fixed exchange rate to better control high inflation rates, in spite of the risk of increased instability as well as vulnerability to external influence. This proved detrimental to much of the region's economy, sparking crises such as the aforementioned Brazilian currency crisis of 1999.

After they suffered from financial crises in the late 1990s, a large number of Latin American states switched from a fixed exchange rate system to a floating exchange rate. Excluding the countries that underwent dollarization, when the citizens of a country primarily use a foreign currency for conducting transactions, many of the region's countries shifted to price targeting; an economic policy targeting predicted prices rather than relying on foreign exchange rates. Therefore, when capital flows halted or diminished during the 2009 economic recession, most of the region swiftly responded by purposely depreciating their currency.

Expanding fiscal and monetary policy

For the last decade, Latin America's fiscal and monetary policies have had a strong fiscal procyclicality. …