Economia 2.2 (2002) vii-xii
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This fourth issue of Economía contains papers presented at the panel meeting held on 19 October 2001 in Montevideo, Uruguay.
In our initial issue, which came out in the fall of 2000, I ventured that Latin American economists could perhaps afford to turn their attention away from macroeconomic crises and toward longer-term issues. True, Brazil and Ecuador had just gone through financial turmoil, and concerns about Argentina were mounting. But those troubles seemed small in comparison to the much lower inflation, slimmer budget deficits, and stronger banks that practically all Latin American countries had achieved over the previous decade.
Well, it wasn't safe to go back in the water quite yet. The Argentine meltdown has returned macroeconomic stability to the top of the agenda. And as Guillermo Calvo argues in his Presidential Address to LACEA, Argentina is only the most serious example of a broader problem. Globalization has brought many benefits to Latin America, but large and very volatile capital flows are not one of them. Calvo documents a phenomenon he labels sudden stops, in which a capital inflow boom (such as the one that occurred in Latin America in the first half of the 1990s) can turn into a race for the exits overnight, leaving countries no option but to turn the current account around by cutting imports, consumption, and growth.
What causes sudden stops? The currently fashionable theory in Washington is moral hazard: policymakers in developing countries overspend and overborrow on the supposition that they may be bailed out if things go wrong, until eventually their debts become unsustainable and lenders stop lending. Calvo argues that this view has "slim empirical support" and that it requires emerging market policymakers to suffer from "a fantastic lack of judgment, bordering on the insane." More plausible is an alternative view he terms globalization hazard. Specifically, poor information [End Page vii] and investors' susceptibility to rumors, coupled with certain vulnerabilities in borrowing countries (including the dollarization of liabilities and weak fiscal institutions), open the door for self-fulfilling contagion: if a country is perceived as risky, then investors dump its securities, triggering a painful adjustment that will make the investors' worst fears about the country come true. This is a systemic problem, Calvo argues, that cannot be solved by better policies in individual borrowing nations. He proposes an emerging country fund that could intervene in special circumstances, buying the bonds of these countries to prevent contagion and a generalized meltdown.
But not all macroeconomic news in Latin America is bad. A handful of countries—most prominently Brazil, Chile, and Mexico—seem to have found a way to combine anti-inflationary credibility with the exchange rate flexibility necessary to face external shocks. The magic potion is called inflation targeting, and according to Klaus Schmidt-Hebbel and Alejandro Werner, it is working wonders. They report that those three countries have been quite successful in meeting inflation targets and attaining relatively low sacrifice ratios and output volatility levels after adopting inflation targeting. The explicit targets are becoming increasingly credible, as shown by the fact that inflation deviation forecast errors have declined significantly since the adoption of the regime, while the influence of volatile inflation shocks on core inflation has been either small or negative.
Still, inflation targeting remains controversial in some quarters. One issue is whether the need to hit short-run targets may compel policymakers to avoid depreciations at all costs (the so-called fear of floating hypothesis), thereby making inflation targeting indistinguishable from (and just as vulnerable as) exchange rate targeting. Here Schmidt-Hebbel and Werner also report good news: pass-through coefficients from the exchange rate to domestic prices seem to be falling as inflation targeting systems mature. If that is so, central banks may be more relaxed about letting the currency move without fears of re-igniting inflation. Other concerns over inflation targeting are thornier: for instance, can it work in highly dollarized economies? It is not a coincidence that Brazil and Chile (and, to a lesser extent, Mexico) are among the least dollarized nations in...