A BROAD VIEW OF MACROECONOMIC STABILITY

JOSÉ ANTONIO OCAMPOUNDER-SECRETARY-GENERAL

UNITED NATIONS

A BROAD VIEW OF A BROAD VIEW OF MACROECONOMIC STABILITYMACROECONOMIC STABILITY

Not only inflation and fiscal balance, but also: Economic activity and employment External sector balance Balance sheets of financial and non-financial agents

Counter-cyclical macroeconomic policies are key So, need to go beyond “inflation targeting”: Output

and real exchange targeting, additional instruments… …and supportive international financial institutions

MACROECONOMIC (IN)STABILITY (1)MACROECONOMIC (IN)STABILITY (1)

Markets are inherently unstable This is partly a question of price and wage

“rigidities”… …but particularly of the functioning of financial

markets (risk/information asymmetries generate inherently incomplete markets): Alternation of high “risk appetite” and “flight to

quality” Rationing of credit, particularly during downturns Contagion

MACROECONOMIC (IN)STABILITY (2)MACROECONOMIC (IN)STABILITY (2) For developing countries: strong cyclical swings and pro-

cyclical macro policies This reflects inherent asymmetries of the international

system: Different capacity to issue debts in domestic

currencies Degrees of financial market development Size of markets

Features of financial cycles: Variations in availability, price and maturities Short-term but, particularly, medium-term fluctuations

Self-insurance is possible but costly

UNSTABLE ACCESS TOEXTERNAL FINANCING…

(20)

20

60

100

140

180

22019

80

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Bill

ions

of d

olla

rs

Net direct investment

Net private capital flows

… … AND VOLATILE SPREADSAND VOLATILE SPREADS

Spreads on JP Morgan EMBI Global and US High-Yield Bonds October 1994 to June 2006

0

200

400

600

800

1000

1200

1400

1600

1800

Oct-94

Feb-9

5

Jun-

95

Oct-95

Feb-9

6

Jun-

96

Oct-96

Feb-9

7

Jun-

97

Oct-97

Feb-9

8

Jun-

98

Oct-98

Feb-9

9

Jun-

99

Oct-99

Feb-0

0

Jun-

00

Oct-00

Feb-0

1

Jun-

01

Oct-01

Feb-0

2

Jun-

02

Oct-02

Feb-0

3

Jun-

03

Oct-03

Feb-0

4

Jun-

04

Oct-04

Feb-0

5

Jun-

05

Oct-05

Feb-0

6

Jun-

06

Bas

is P

oin

ts

EMBI/EMBI Global

US High-Yield Bonds

Pre-Asian Crisis EM Spreads

Asian Crisis

Source: ECLAC, on the basis of data from Merrill Lynch's U.S. High-Yield Master II Index (H0A0), and JP Morgan's EMBI (until November 1997), and EMBI Global (from December 1997 to June 2006).

Mexican Crisis

MACRO POLICIES:MACRO POLICIES:THE EXCHANGE RATE REGIME (1)THE EXCHANGE RATE REGIME (1)

With trade and capital account liberalization, loss of policy instruments to manage shocks.

Thus, greater reliance on exchange rate… … but exchange rate fluctuations have a

counter-cyclical trade but pro-cyclical wealth effects…

… and are subject to conflicting demands: Demand for stability (price stability, stable

trade incentives, avoiding pro-cyclical wealth effects)

Demand for flexibility (room of maneuver to manage shocks)

MACRO POLICIES:MACRO POLICIES:THE EXCHANGE RATE REGIME (2)THE EXCHANGE RATE REGIME (2)

An adequate management of the exchange rate regime must recognize the multiple objectives of macroeconomic policy…

…which implies that some degree of exchange-rate targeting is essential…

…and is the normal policy option

THE TRADITIONAL VIEW:THE IMPOSSIBLE TRINITY

Figure 2

C

BA

Capital mobility

Autonomyto manage

exchange rates

Autonomyto manage

interest rates

PROBLEMS WITH PROBLEMS WITH THE TRADITIONAL VIEWTHE TRADITIONAL VIEW

“Credibility” of pegs (even hard pegs) vary and are pro-cyclical, thus making this instrument more procyclical in developing countries.

“Monetary autonomy” under flexible exchange rates is also limited: Pro-cyclical wealth effects. Supply effects of exchange rates on domestic prices Endogeneity of capital flows.

So, the room for monetary autonomy may be greater under “intermediate regimes”, but: Effective capital account regulations are key Costs of counter-cyclical reserve management Credibility issues

MACRO POLICIES:MACRO POLICIES:FISCAL POLICY (1)FISCAL POLICY (1)

Fiscal policy can always play a counter-cyclical role. But markets push it in a different direction:

Taxes, financing and debt service are procyclical Contingency financing is also procyclical.

And there are political-economy arguments that push in the same direction: Compensating pro-cyclical booms of private spending

is politically difficult If there was austerity during the preceding crisis, it is

also difficult to justify it during booms Procyclical fiscal policy has adverse effects on the

efficiency of public sector spending and on growth.

PROCYCLICAL POLICIESPROCYCLICAL POLICIES

REGIONCYCLICALITY OF

FISCAL POLICY (INDEX)

OECD - 0.11 (countercyclical)

High-to-Middle Income Developing Countries

0.28 (highly procyclical)

Middle-to-Low Income Developing Countries

0.17 (moderately procyclical)

Low-Income Countries 0.28 (highly procyclical)

Africa 0.30 (highly procyclical)

Latin America 0.25 (highly procyclical)

Asia 0.16 (moderately procyclical)

Pro-cyclical macroeconomic policy in developing countries has been harmful for growth

Pro-cyclical fiscal policies negatively affect long term-growth

Unstable public spending have negatively affected investments in infrastructure and human development

MACRO POLICIES:MACRO POLICIES:FISCAL POLICY (2)FISCAL POLICY (2)

Policy options: Define a structural stance of the public sector. Actively use stabilization funds Automatic stabilizers (spending or taxes) may be

preferable to discrete decisions.

CAPITAL MANAGEMENT:CAPITAL MANAGEMENT:CAPITAL ACCOUNT REGULATIONS (1)CAPITAL ACCOUNT REGULATIONS (1)

Second best intervention: segment what is already segmented.

Traditional regulations: segment according to residents and non-residents, and existing economic links.

For countries already integrated in to world capital markets: Temporary administrative controls (Malaysia,

1994 and 1998) Price-based regulations (Unremunerated

Reserve Requirements, URR).

CAPITAL MANAGEMENT:CAPITAL MANAGEMENT:CAPITAL ACCOUNT REGULATIONS (2)CAPITAL ACCOUNT REGULATIONS (2)

Lessons from experience: Both controls on outflows and inflows can work,

but quantitative restrictions may be easy to administer

Dynamic adjustment is necessary to close loopholes, and in any case regulations are “leaky”

Traditional controls work better if the objective is to reduce procyclical flows.

Quantitative controls have stronger effects… … but price-based regulations are also effective Capital account regulations are a complement, not

a substitute of adequate macro policy

THE EFFECT OF CAPITAL-ACCOUNT REGULATIONS

Inflows

Interest rate spread(i - i* + e)

i: Domestic real interest ratei*: External real interest ratee: Annual variation of of the real exchange rate

A

B

C

CAPITAL MANAGEMENT:CAPITAL MANAGEMENT:MACRO-PRUDENTIAL REGULATIONSMACRO-PRUDENTIAL REGULATIONS

Risks that financial sector faces have a large macroeconomic component: Financial markets are pro-cyclical Traditional regulation have a pro-cyclical bias Price-sensitive risk management is also pro-cyclical.

Essential tools: Forward-looking provisioning (rather than capital) Discretionary prudential provisioning, based on

growth of credit (general, by sector, by agent) Regulation of maturity and, particularly, currency

mismatches. Valuation of collaterals.

CAPITAL MANAGEMENT:CAPITAL MANAGEMENT:PUBLIC SECTOR LIABILITY MANAGMENTPUBLIC SECTOR LIABILITY MANAGMENT

Maturity of domestic liabilities of the public sector matter.

Avoid dollar/euroization of domestic liabilities

Counter-cyclical swings between domestic and external financing.

INTERNATIONAL COOPERATIONINTERNATIONAL COOPERATION

The room of maneuver for counter-cyclical policies should be at the center

Surveillance to avoid building up unsustainable dynamics.

Smoothing financing at the source IFIs as “market makers” for counter-cyclical

instruments Counter-cyclical financing.