LAC-EU ECONOMIC FORUM 2013 Session 1 Cycles, Crisis and the Asymmetric Response of Macroeconomic Policy Distinctive features of the Latin American and Caribbean business cycle Daniel Titelman Esteban Pérez Caldentey Pablo Carvallo Financing for Development Division

Main messages Using quaterly data for the period for a sample of 83 countries worldwide we show that the Latin American and Caribbean (Latam) cycle exhibits two distinctive features at the regional and sub regional levels:  Expansions tend to be weaker in terms of duration and intensity relative to other regions.  Contractions are not longer or more intense than in other regions of the world. These results are particularly relevant when comparing the dynamics of the cycle of Latin America and the Caribbean to that of East Asia and the Pacific.  Expansions last 33 and 14 quarters on average in East Asia and the Pacific and Latam  The output gain in expansions is 39% and 26% in East Asia and the Pacific and Latam. These distinctive features are also present in the behavior of productivity which is a key determinant of long-run growth.  The empirical evidence shows that in the expansionary phase of the cycle, the rise in productivity in East Asia and the Pacific is roughly twice that of Latin America and the Caribbean. Another distinctive feature of the cycle dynamics in Latin America and the Caribbean pertains to the fact that the effects of the contraction on public investment surpass those of the expansion.

The methodology and approach The characteristics of the cycle are analyzed using two standard cycle methodologies Classical Cycle Defines the cycle as a series of turning points in the level of real aggregate economic activity (Sequential pattern of expansions and contractions ). Deviation Cycle Defines the cycle in terms of the deviations of real aggregate economic activity from its trend (or potential output). For each of the methodologies an algorithm was used (Bry-Boschan) to determine the turning points in the series. In the case of the Classical cycle two other algorithms were also performed (Calculus and Okun). Once the turning points are identified two indicators were computed to characterize the cycle: Duration Amplitude Amplitude and duration are used to assess the cumulative effect of an expansion or contraction

The Classical and Deviation Cycle methodologies produce different characterizations of the cycle The Classical Cycle tends to produce shorter contractions than the Deviation Cycle.  A downturn in the Classical Cycle occurs when  Contrarily, in the Deviation Cycle a downturn occurs when From the definition of a contraction in both methodologies, it follows that:  The amplitude of a contraction in the Classical Cycle will always have a negative sign.  However, this need not be the case when applying the Deviation Cycle. The Deviation Cycle fails to capture the asymmetry between the contraction and the expansion phases.  In the Deviation Cycle the cyclical component is stationary and the positive and negative deviations will tend to cancel out over time.  Stationarity is not an issue in the Classical Cycle approach.

CountriesEMEEME RegionsDCPeriodVariables EAPECAMENASSASALAC Financing for Development Division (2013) Quarterly GDP Male (2009, 2010) Quarterly Industrial and agricultural output Du Plessis (2006) 2421……1… Quarterly GDP, C, I,, r, FS Cashin (2004) 106…………… Yearly GDP Craigwell (2004) 33……………3… Quarterly GDP Calderón & Fuentes (2012) … Quarterly GDP Rand & Tarp (2002) 15141… Quarterly Industrial production Index Pérez Caldentey & Pineda (2010) Yearly GDP, GDP per capita The exercises were carried out with a comprehensive and representative data set Source: Financing For Development Division (2013)  The sample includes 83 countries worldwide among which 44 are emerging market economies (EMEs) and 39 are high income economies (DC).  It includes all South American and Central American economies and six Caribbean economies. Data sample for selected studies on the business cycle in developing countries and Latam

The results show that, with independence of the methodology used, the duration of expansions in Latin America and the Caribbean tend for the most part to be shorter than those of other developing regions Median quarterly duration the contractionary phase of the cycle for selected regions of the world ( ) Classical Cycle (In quarters) Deviation Cycle (In quarters) East Asia and the Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia …8.5 Sub-Saharan Africa High Income Source: Financing For Development Division (2013)

In a similar manner, expansions are less intense than in other developing regions Median amplitude of the expansionary phase of the cycle for selected regions of the world Classical Cycle (In percentages) Deviation Cycle (In percentages) East Asia and the Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia …17.8 Sub-Saharan Africa High Income Source: Financing For Development Division (2013)

A similar result obtains at the sub regional level… Classical Cycle (In percentages) East Asia and the Pacific 39.0 Europe and Central Asia 43.8 Latin America and the Caribbean 26.3 South America 27.9 Central America 27.0 Mexico 25.6 Middle East and North Africa 15.6 Sub-Saharan Africa 40.9 High Income26.3 Median amplitude of the expansionary phase of the cycle for selected regions of the world Source: Financing For Development Division (2013)

Placing the focus of analysis on the last expansionary phase in Latin America and the Caribbean prior to the crisis ( ) corroborates the comparative amplitude result During the period Latin America and the Caribbean recorded the highest average rate of growth in over three decades.  The regional average per capita growth rate reached 3.7% surpassing not only that of the 1980s (-0.8%), 1990s (1.4%) and also that of the 1970s (3.2%).  Other regions of the world also registered historical growth rates during this period. A comparative analysis for this period shows that the median amplitude of the expansion reached 30% for Latam and 50% for East Asia and the Pacific.  A similar result is obtained when comparing Latam and the Middle East and North Africa

Turning to contractions, the evidence indicates that their duration in the case of Latin America and the Caribbean tends to conform to those of other regions Median quarterly duration the contractionary phase of the cycle for selected regions of the world Source: Financing For Development Division (2013) Quarters

Also, the intensity of the contraction in Latin America and the Caribbean does not differ significantly from that of other regions of the world Median amplitude of the contractionary phase of the cycle for selected regions of the world (In percentages) Percentages Source: Financing For Development Division (2013)

The dynamics and distinctive features of the Latin American and Caribbean cycle are not exclusively relevant to the short-run…  These are also reflected in the behavior of variables such as productivity and investment which are generally identified as determinants of long-run growth. Amplitude (Percentage) Duration (Years) East Asia and the Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa High Income Duration and amplitude of the expansionary phase of the labour productivity cycle for selected regions of the world using the Classical Cycle methodology Source: Financing For Development Division (2013)

Another distinctive feature linking short-run cycle fluctuations to long-run growth is provided by the asymmetric behavior of investment  Available data for six of the largest economies of the region show that the declines in public infrastructure investment expenditure in the contractionary phase of the cycle tend to be sharper than any increase during the recovery phase. Percentages Latin America (selected countries): amplitude of expansions and contractions of the cycle of public investment in infrastructure, (yearly data) Source: Financing For Development Division (2013)

Jointly with the stylized cycle dynamics, the evidence linking short to long run performance may explain why Latin America and the Caribbean have lagged behind other developing regions Trend GDP for Latin America and the Caribbean and East Asia and the Pacific, (Annual logarithmic data) Logarithmic Scale Source: ECLAC (2012) Period I Period II

Conclusions The analysis using a sample of 83 countries worldwide and two cycle methodologies shows that:  First and most importantly, Latam register weaker expansions, both in terms of duration and intensity, than those of other regions and in particular than those of the East Asian and Pacific region. The most recent expansion ( ) which is by far one of the most intense in the history of the region corroborates the result that expansions are weaker in Latam with respect to other regions.  A second distinctive feature is that Latin America and then Caribbean’s contractions conform in terms of duration and amplitude to those of the rest of the world. The specificities of the cycle are not only relevant to the short-run. They are also reflected in the behavior of variables such as productivity and investment which are linked to long-run growth performance.

These findings open important avenues to further explore and analyze the short and long-term performance of Latin America and Caribbean economies Cycle analysis should increase its focus on the nature and behavior of expansions.  Contractions tend to be somewhat homogeneous across regions in terms of duration and amplitude. Contrarily, expansions are heterogeneous in terms of both indicators.  Improving our knowledge of the differences in the expansionary dynamics of countries and regions, can further our understanding of the differences in their rates of growth and levels of development. The management of the cycle affects the short-run fluctuations of economic activity and hence volatility. But in addition, it is not trend neutral.  Hence, the effects of aggregate demand management policies may be more persistent over time and less transitory than currently thought.