1. Macroeconomic Coordination in Latin America: Some Lessons from the Mercosur Experience José Luis Machinea and Guillermo Rozenwurcel ECONOMIC COMMISSION FOR LATIN AMERICA AND THE CARIBBEAN Seminar on Regional Financial Arrangements New York, July 14th 2004

2. Main topics Incentives for coordinationIncentives for coordination Costs and difficulties of coordinationCosts and difficulties of coordination Volatility of real exchange ratesVolatility of real exchange rates Monetary UnionMonetary Union Macroeconomic coordinationMacroeconomic coordination –The European experience –The Latin American experience ConclusionsConclusions

3. Incentives for coordination Interdependence (trade and financial) Political support for a deeper integration Discipline under domestic pressure Improvement of credibility (buy reputation) Elimination of distortions and reduction of fiscal costs Reduction of volatility in the block

4. Trade interdependence a) Intra-regional exports as percentage of total exports

5. Trade interdependence a) Intra-regional exports as percentage of regional GDP Source: own calculations based on DOTS (2001) and WDI (2001).

6. MERCOSUR Intraregional exports

7. Financial interdependence Lack of financial relations But –Similar external financial shocks –Contagion

8. Financial shocks Correlation of capital movements

9. Country risk

11. Incentives for coordination Interdependence (trade and financial) Political support for a deeper integration Discipline under domestic pressure Improvement of credibility (buy reputation) Elimination of distortions and reduction of fiscal costs Reduction of volatility in the block –Nobody wants to have a partner with a highly volatile economy. Alternatives: reduce interdependence or find cooperation mechanism to reduce volatility

12. Main topics Incentives for coordinationIncentives for coordination Costs and difficulties of coordinationCosts and difficulties of coordination Volatility of real exchange ratesVolatility of real exchange rates Monetary UnionMonetary Union Macroeconomic coordinationMacroeconomic coordination – The European experience –The Latin American experience ConclusionsConclusions

13. Autonomy Cyclical Synchronism Differences in the underlying model (Argentina and Brazil during the nineties) Long-run benefits and a high discount rate during crises Doubts about the cooperative behavior of partners (prisoner’s dilemma) Coordination: costs and difficulties

14. Interdependence (or Dependence?) Regional GDP distribution Nota: el indicador se calculó como la participación de cada país en el PBI regional promedio del período 1990-1999. Fuente: Cálculos propios sobre datos del WDI (2001)

15. Autonomy Cyclical Syncronism Differences in the underlying model (Argentina and Brazil during the nineties) Long-run benefits and a high discount rate during crises Doubts about the cooperative behavior of partners (prisoner’s dilemma) Coordination: costs and difficulties

16. Cyclical synchronism

17. Cyclical synchronism Cyclical synchronism

18. Autonomy Cyclical Synchronism Differences in the underlying model (Argentina and Brazil during the nineties) Coordination: costs and difficulties Long-run benefits and a high discount rate during crises Doubts about the cooperative behavior of partners (prisoner’s dilemma)

19. Main topics Incentives for coordinationIncentives for coordination Costs and difficulties of coordinationCosts and difficulties of coordination Volatility of real exchange ratesVolatility of real exchange rates Monetary UnionMonetary Union Macroeconomic coordinationMacroeconomic coordination – The European experience –The Latin American experience ConclusionsConclusions

20. Volatility: the exchange rate variability Size Effects Economic (impact on trade) Political-Economy Causes Fundamentals Stabilization programs (different timing) External shocks Contagion Self-fulfilling prophecies Different Exchange rate regimes

21. MERCOSUR: Selected Real Effective Exchange Rates

22. MERCOSUR: Bilateral Real Exchange Rates

23. Andean Community: Selected Real Effective Exchange Rates

24. Andean Community: Bilateral Real Exchange Rates

25. Central America: Selected Real Effective Exchange Rates

26. Central America: Bilateral Real Exchange Rates

27. Volatility of Bilateral Real Exchange Rates ( standard coefficient as % of mean)

28. Volatility: the exchange rate variability Effects Economic (impact on trade) Political-Economy Causes Fundamentals Stabilization programs (different timing) External shocks Contagion Self-fulfilling prophecies Different Exchange rate regimes Size

29. Volatility: the exchange rate variability Policy alternatives to reduce variations in the ER or its effects – Monetary Union – Macroeconomic Coordination – Exchange rate compensatory mechanism

30. Main topics Incentives for coordinationIncentives for coordination Costs and difficulties of coordinationCosts and difficulties of coordination Volatility of real exchange ratesVolatility of real exchange rates Monetary UnionMonetary Union Macroeconomic coordinationMacroeconomic coordination – The European experience –The Latin American experience ConclusionsConclusions

31. Monetary Union No possibility of MU in the short-run based on OCA Importance of financial interdependence, but consider: –Magnitude of shocks –Attempts by country to differentiate itself from the partner in difficulties. Main problem: lack of reputation Dynamic of monetary union, but consider the low exit costs Political will: absence of a regional agenda or large gap between reality and rhetoric

32. Main topics Incentives for coordinationIncentives for coordination Costs and difficulties of coordinationCosts and difficulties of coordination Volatility of real exchange ratesVolatility of real exchange rates Monetary UnionMonetary Union Macroeconomic coordinationMacroeconomic coordination – The European experience –The Latin American experience ConclusionsConclusions

33. Macroeconomic coordination 1. The European experience Exchange rate policy is crucial Fiscal and monetary policies should converge Room for opportunistic behavior should be reduced over time The evaluation of the commitment must be transparent Supranational institutions are important Macro policy coordination must parallel advances in other integration areas.

34. Main topics Incentives for coordinationIncentives for coordination Costs and difficulties of coordinationCosts and difficulties of coordination Volatility of real exchange ratesVolatility of real exchange rates Monetary UnionMonetary Union Macroeconomic coordinationMacroeconomic coordination – The European experience –The Latin American experience ConclusionsConclusions

35. Macroeconomic coordination 2. The realities of the region Demand for Coordination The regional experience: the failed attempts to convergence What should be coordinated? –Convergence of macroeconomic variables –Structural reforms –Not the exchange rate The importance of the exchange rate regime –Floating regime advisable, but not without problems –Harmonization of inflation targets might help

36. Macroeconomic coordination 2. The realities of the region External Factors: –Volatility of terms of trade

37. Real shocks 1. Volatility of Terms of Trade and Export Prices

38. Magnitude of volatility, 1971-2000 Terms of trade volatility as % of total exports

39. Macroeconomic coordination 2. The realities of the region Volatility of external environment: –Volatility of terms of trade –Volatility of capital flows

40. Magnitude of volatility, 1971-2000 Private capital flows volatility as % of exports

41. Financial shocks Magnitude of capital flows volatility

42. Liquidity funds Counter-cyclical funds Regional stabilization funds Macroeconomic coordination 2. The realities of the region External Factors: –Volatility of terms of trade –Volatility of capital flows

43. Macroeconomic coordination 2. The realities of the region Incentives for coordination –Political will: the missing link –The lack of incentives –Lack of reputation ( Being considered a responsible country is not tied to meeting commitments within the area ) –Volatility of the exchange rate and little trade interdependence –Financial contagion induces differentiation –Europe had exogenous coordination and external shocks were less important

44. Macroeconomic coordination 2. The realities of the region What can be done? Internal incentives Transparency of Commitments is crucial But, effective sanctions are not credible Committee of Experts: peer pressure Deepening integration: increase the demand for coordination Counter-cyclical policies: the role of structural deficit and stabilization funds

45. Macroeconomic coordination 2. The realities of the region External incentives –International stabilization funds (real and financial shocks) –The role of Multilateral Banks (loans related to the integration process) –Regional financing: a key actor if enough funds are available (needs of support from multilateral) Lack of correlations of terms of trade helps But the problems could be: –Asymmetry of Size (Brazil) –Similar financial shocks

46. Real shocks 2. Terms of Trade and Export Prices Correlation

47. Conclusions Macroeconomic coordination only if deep integration is the final purpose Deep integration goes beyond macroeconomic: the agenda should include other relevant issues as well Need to reduce real exchange rate volatility Monetary Union: a long-term perspective The beginning of coordination: macroeconomic stability at national level The cooperative game

48. External environment –Multinational Institutions –Regional Funds External incentives: the role of Multilateral Banks Macroeconomic coordination and FTAA Conclusions

49. Macroeconomic Coordination in Latin America: Some Lessons from the Mercosur Experience José Luis Machinea and Guillermo Rozenwurcel ECONOMIC COMMISSION FOR LATIN AMERICA AND THE CARIBBEAN Seminar on Regional Financial Arrangements New York, July 14th 2004