Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Ernesto Talvi, CERES Alejandro Izquierdo, IADB Coordinators Prepared for Presentation at the XXIX Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC, April 22 nd, 2009.

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) I.Policy Trade-Offs II.Policy Principles POLICY TRADE-OFFS FOR UNPRECEDENTED TIMES: A LIQUIDITY APPROACH

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) CONFRONTING THE GLOBAL CRISIS IN LATIN AMERICA: POLICY TRADE-OFFS  Under precarious access to credit markets liquidity considerations become paramount  The benefits of alternative policies should be primarily weighed against their immediate impact on the international liquidity ratios (ILRs) of a country and how they affect the likelihood of a liquidity crisis and a severe output contraction

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Confronting the Global Crisis in Latin America: Policy Trade-Offs Mitigate Recessionary Pressures Trade - Off Weaken Liquidity Position EXPANSIONARY FISCAL POLICY ILR with expansionary policy GDP with expansionary policy and no liquidity crisis Threshold GDP with no policy ILR t ILR with no policy GDP t 0123 Threshold GDP with expansionary policy and liquidity crisis

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Confronting the Global Crisis in Latin America: Policy Trade-Offs Mitigate Recessionary Pressures Trade - Off Weaken Liquidity Position EXPANSIONARY MONETARY POLICY DEBT BUYBACKS CORPORATE BAILOUTS EXPANSIONARY FISCAL POLICY

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) I.Policy Trade-Offs II.Policy Principles POLICY TRADE-OFFS FOR UNPRECEDENTED TIMES: A LIQUIDITY APPROACH

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) POLICY PRINCIPLES: MAIN GOALS  Anticipate gathering problems early on to act in a timely fashion  Design a set of policies that prevent countries from entering into financially fragile territory that might expose them to a liquidity crisis and a major economic collapse

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) (Latin EMBI and Latin CEMBI, Yield in %) Sovereign and Corporate Bonds in US (US 10y T-Bonds and US BBB Corporate, Yield in %) Latin EMBI Latin CEMBI Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 Source: Bloomberg US 10Y BBB US 10YBBB Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar Sovereign and Corporate Bonds in LAC POLICY PRINCIPLES: CONSTRAINTS

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators)  Precarious access to credit markets for many emerging market governments calls for multilaterals to step in and play a key role as a lenders-of-last resort, akin to the role that credible governments, such as the US government, play domestically  The question then is not whether multilaterals should play a key role in the current crisis, but which is the most effective way to channel their intervention and at what financial cost THE ROLE OF MULTILATERALS POLICY PRINCIPLES

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) 1.Strengthen the role of multilateral institutions. Multilateral support will be vital under precarious access to credit markets. 2.Move away from short-term financing. Multilaterals should avoid short-term emergency financing and only consider medium to long-term financing in order to partially “complete” markets in terms of maturities. 3.Redefine the emphasis of multilateral support. Multilaterals should not only provide medium to long-term financing for fiscal stimulus –when fiscal sustainability is not at stake– but more importantly, they should provide for long-term refinancing of maturing debt obligations. 4.Ensure that countries work towards sustainable fiscal policy while strengthening social protection. Multilateral support should be complemented with incentive-compatible conditionality, to ensure fiscal sustainability and strengthen social protection. POLICY PRINCIPLES

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Multilaterals Confronting the Global Crisis in Latin America: The Role of Multilaterals Financial Support  Stimulus packages (when fiscal sustainability not at stake)  Long term refinancing of public debt amortizations coming due

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) ILR Dynamics Under Alternative Policies (LAC-7, L-Shaped Scenario, ILR 2 ) Normal International Financial Conditions Precarization of Flows and Stocks Full Financing of Flows and Precarization of Stocks LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. ILR 2 t = Reserves t / (Public Debt Amortizations t+1 + Short Term Private External Debt Amortizations) 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% 125%

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Multilaterals Confronting the Global Crisis in Latin America: The Role of Multilaterals Financial Support  Stimulus packages (when fiscal sustainability not at stake)  Long term refinancing of public debt amortizations coming due Incentive-Compatible Conditionality  Targets to achieve fiscal sustainability (IMF)  Design of optimal expenditure policy (MDBs)

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Full Financial Support by Multilaterals: Financial Costs (LAC-7, millions of dollars) Public Debt Amortizations Fiscal Deficit Financing Passive Fiscal Deficit Geithner’s Proposal* Total Borrowing Requirements ,903173,857401,760 97,319138,926236,245 17,80420,79938, ,222312,783638,005 79,515118,127197,642 LAC-7 is the sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. *Assuming full impact of the Keynesian multiplier on output and fiscal revenues. Domestic External33,81818,39952, ,084155,458349,542 Scenario of deficit support and minimum rollover support to sustain liquidity ratios above 1: US$ 470 billion. Scenario a la Guidotti-Greenspan (public and private external obligations only): US$ 453 billion

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) ILR Dynamics Under Alternative Policies (LAC-7, L-Shaped Scenario, ILR 2 ) Normal International Financial Conditions Precarization of Flows and Stocks Full Financing of Flows and Precarization of Stocks LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. ILR 2 t = Reserves t / (Public Debt Amortizations t+1 + Short Term Private External Debt Amortizations) Full Financing of Flows and Partial Financing of Stocks 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% 125% Scenario of deficit support and minimum rollover support to sustain liquidity ratios above 1: US$ 470 billion. Scenario a la Guidotti-Greenspan (public and private external obligations only): US$ 453 billion

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators)  A strategy by the IMF and multilaterals that only pays attention to financing countercyclical fiscal policies is incomplete and ignoring the impact of expansionary policy on liquidity ratios can be a costly mistake. CLOSING REMARKS  It is necessary that lender (and borrower)-of-last-resort functions, similar to those that governments perform in developed economies, be recreated for LAC by multilateral institutions, so that liquidity concerns are kept at bay.  This strategy has three basic requirements: iii. a careful country-by-country analysis that determines the optimal amount of liquidity support cum fiscally sustainable combinations of expenditure increasing and expenditure switching policies ii. an appropriate division of labor between the IMF and MDBs i.a strengthening of the resources of multilateral institutions to allow them to act with a scale commensurate to the tasks at hand

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Ernesto Talvi, CERES Alejandro Izquierdo, IADB Coordinators Prepared for Presentation at the XXIX Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC, April 22 nd, 2009.