The Global Crisis and LAC Views from Washington

1. The Global Crisis and LACViews from Washington Guillermo Calvo Columbia University Inter-American Development Bank, Vice Presidency for Sectors and Knowledge Research Department and the Regional Policy Dialogue, Washington, DC, April 24, 2009

2. Main Policy Innovations • G20 re-funding and re-founding of the Fund. • Pro-active monetary and financial policy in the G7. • G7 Stimulus packages.

3. I. G20 Re-funding and Re-founding the Fund • The G20 decision to substantially increase IMF funding, and the new IMF Flexible Credit Line, represent major strategic changes in international financial cooperation. • The FCL offers an alternative to international reserve accumulation, a costly self-insurance scheme. • The FCL could be instrumental in recycling Flight-to-Quality capital, and preventing BOP crises.

4. Remarkably, a US$47 billion FCL for Mexico was approved, even though Mexico is not suffering from a balance-of-payments, BOP, crisis. • In contrast, in 1995 Mexico got a US$50 billion package many weeks after BOP crisis erupted – too late for preventing major output collapse. • Thus, the Fund is beginning to act as a regular central bank (at a global level).

5. II. Pro-active Monetary and Financial Policy in the G7 • Lowering of policy interest rates and the many other operational innovations at the Fed and other G7 central banks may have contributed to: • Protecting EMs from contagion through the capital market (as during the 1998 Russian crisis). • Surge of capital flows to EMs until mid 2008 • Low yields of EM bonds.

6. ExternalFinancial Conditions for EMs(daily data, EMBI+, bps, last value 04/07/09) ENRON Effect Greenspan’s “conundrum” testimony Lehman Brothers files for bankruptcy Fears of FED tightening Basis points Yields Pre-Asian Crisis Yield =-12% Spreads =+54% Pre-Asian Crisis Spread Beginning of improvement in international financial conditions Source: Bloomberg.

7. US Junk & EM Bonds (yields in %, last value 04/07/09) US Junk EM Sovereign EM Corporate Note: (1) EM Corporate = Credit Suisse Corporate Bond. (2) EM Sovereign = JP Morgan EMBI+ Sovereign. (3) US Junk= MSCI High Yield Bonds. Source: Bloomberg.

8. III. G7 Stimulus Packages • Several experts and commentators expect that effects on EM output will be modest. • Moreover, these packages could contribute to further crowding out of capital flows from EM, especially if global output takes time to react to stimulus packages.

9. Inflation Risks in LAC

10. Global inflation may surge as credit starts to flow to the private sector. • Commodity prices are likely to be the first in line to rise • which, as experienced in 2008 Q-I, will result in higher EMs’ inflation. • G7 central banks are unlikely to tighten monetary policy before they see output firmly recuperating and inflation reflected in their CPIs.

11. Therefore, as inflation flares up, LACs are likely to be on their own • And may face a serious tradeoff between • stopping inflation and • stopping output’s rebound.

12. Commodity Prices(daily data, Index 3-Sep-07= 100, last value 4/7/09) Source: Bloomberg.

13. The Global Crisis and LACViews from Washington Guillermo Calvo Columbia University Inter-American Development Bank, Vice Presidency for Sectors and Knowledge Research Department and the Regional Policy Dialogue, Washington, DC, April 24, 2009