Federal Funds rate have started to recede from the
peaks reached in the fourth quarter of 2008. In the
emerging markets there has been some reduction in
risk spreads as well.
However, governments appear unable to deal with
the more systemic effects of the crisis.
There are two basic problems with the
financial strategies unveiled so far (in
early spring 2009). First, measures directed at the financial sector have not yet
adequately produced a full recognition of
losses and addressed the consequences of
the implied shortfall in bank capital.
The measures taken appear aimed at
treating the effects of the crisis, but not
the root causes. However, the experience of past financial crises around the world suggests that a sustainable
recovery starts only after a floor in asset valuations is
reached and the balance sheet of the financial sector
is cleansed of toxic assets. In this respect, in emerging
market economies where government action can only
be limited by tight budget and liquidity constraints,
financial crises tend to lead to relatively short (but
sharp) V-shaped downturns and recoveries.
5
Second, fiscal policy both in the U.S. and Europe
has been directed at smoothing out the fall in aggregate demand mostly through an increase in government expenditure. But fiscal policy is unlikely to be
very effective as long as confidence is not restored in
the financial system. Moreover, while fiscal stimulus
may work in cyclical downturns in economic activity,
it may be significantly less successful at stimulating
aggregate demand when there is a permanent negative wealth shock.
With the above analysis in mind, what are the
effects on Latin American credit markets and economies? The decline in economic activity in the
advanced world has led to a fall in export volumes
and in commodity prices. Second, the financial or
capital-market channel, so central in previous crises in emerging markets, has threatened to dry up.
A halt in capital flows to Latin America means that
governments as well as private companies may find
themselves without the necessary credit to roll over
their liabilities. In that scenario, fiscal policy tends to
become strongly procyclical, and the private sector is
Are We There Yet? Pablo E. Guidotti
forced into a sharp adjustment.
Indeed, in the fourth quarter of 2008, the region
was experiencing a virtual shut-down of the international capital market, both for governments as well as
for the private sector. Moreover, capital was flowing out
of the region into U. S. Treasuries. As yields on U. S. government bonds hit record lows, risk spreads increased
sharply for all Latin American economies.
In its December 2008 statement, the Latin American Shadow Financial Regulatory Committee (
LASFRC) called on the international community to develop
new mechanisms that could recycle funds back to
emerging market economies in order to tackle the toxic
combination of a freeze in the international capital
market with capital flight.
6 This was needed not only
to get capital flowing back to emerging market economies but also to relieve the burden on U.S. fiscal policy in the fight against recession. By putting in place
mechanisms that mitigate the recessionary effects of
the financial crisis on emerging market economies, the
U.S. economy would benefit through export growth.
Hence, mechanisms such as those proposed by LASFRC would provide the kind of balanced stimulus to
the world economy that the U. S. itself needs to fight its
way out of the recession.
The Need for a Public,
International Lifeline
Given the long-term implications of the current crisis, the LASFRC proposed the establishment of a $250
billion Emerging Market Fund (EMF) to complement,
as well as to make more agile, the role of multilaterals in the region. The EMF would channel resources
through multilateral organizations both to the pri-
spring 2009
americas quarterly 51
