The crisis: How bewildered should we feel? Ricardo Hausmann Center for International Development & Kennedy School of Government Harvard University

Agenda How is the world? How did we get here? What does this diagnostic imply? How scared should we (Latin Americans) be? How much should we change our economic policy beliefs? How will Latin American countries fare?

The world is a mess Biggest global recession since 1929 Synchronized as never before – Sept 15, 2008 Starting in the center, not the periphery Spreading globally instantaneously Amazing collapses in asset values Response includes huge fiscal deficits, zero interest rates, incredible expansions of central bank balance sheets (US, UK and Japan)

What happened? Financial crisis – A heart attack Not much use to discuss what caused it – Too much booze, lack of exercise Or how to prevent the next one – The asymmetry of regulation – Now we want them to lend but they don’t It caused a collapse in counter-party trust …closing down all credit markets …triggering an asset price collapse …and a major decline in demand – Access to credit, wealth effect and lower animal spirits

In other words A network of trust that disappeared Flight to safety Enter the super-borrower – Increase in the ability to borrow of a few big governments They have the capacity to provide temporary rewiring of the global system – Domestic fiscal expansion, GM, Citibank, etc. …but are trapped in a country-focused political process – Global problem, partial solution

Implications The problem – The US is already spending more than it is earning Large current account deficit – …and is accumulating a ton of net debt The alternative (or the complement) – Use the borrowing capacity to expand abroad – Increasing export demand – No increase in net debt: new debt is matched by new assets Implementing – Recapitalize the MDBs – Buy a portfolio of EM securities, as Bernanke is doing with student loans and credit card debt – Give the resources to the IFC to manage

How scared should we (Latin Americans) be? We have been here before – Sudden stop in capital flows (1982, 1994, 1998, 2002) – Deterioration of the terms of trade – Slower export demand..we are more experienced …we have better balance sheets – did not have that much time to do stupid things – The last crisis was as recent as 2002 …but things are also a bit different – Many times in the past we got out through a real depreciation and an export boom – This time around the crisis is global so getting out of it may be more challenging – Like , in the sense that it was a sudden stop and a global recession – but harder: then it was a “desired” recession – it was followed by very rapid global growth

Should we change our ex-ante beliefs? Not much – Old lessons are as good as ever Keep public debt low and well structured – Level, currency denomination, maturity Keep exchange rate flexible and competitive Save fiscal resources in boom times Lean against the wind of excessive capital inflows Keep banks liquid, well capitalized and on a short leash Behave in a credible manner – Budget institutions, credible supervisors, property rights – Contrast Argentina and Uruguay Develop well structured safety net – not just for the chronically poor – …but also for the suddenly impoverished

Should we change our views about crisis management? Not too much Be as anti-cyclical as you can – Do you have access to finance at reasonable cost? – Are domestic real interest rates low? But we have not figured out what to do with our reserves – We accumulated them for a purpose (self-insurance) – But we are not sure what to do with them in a crisis – We have let exchange rates take the hit instead

What would a better international financial system do for us? Have sufficiently flexible access to international liquidity so we can feel more confident to expand at home Hence, would increase the scope for anti- cyclical policies We may need more multilateral lending to cope with a slow recovery of market access – Recapitalized WB and IDB

Who will do well? Who will do poorly? Disciplined, market friendly countries will recover – Brazil, Chile, Colombia, Costa Rica, Mexico, Peru, Uruguay – With differences, given their different structures They may even surprise – Crises change the choice between exploitation vs. exploration – Leads to new diversification Neo-populists and neo-totalitarian governments will do poorly – High taxes on exports, no access to credit markets, investor unfriendly, no economic freedom to spur innovation, – Argentina, Ecuador, Nicaragua, Venezuela