Alejandro Izquierdo

Sudden Stops, the Real Exchange Rate, and Fiscal Sustainability: Argentina's Lessons

We offer an alternative explanation for the fall of Argentinas Convertibility Program based on the countrys vulnerability to Sudden Stops in capital flows. Sudden Stops are typically accompanied by a substantial increase in the real exchange rate that breaks havoc in countries that are heavily dollarized in their liabilities, turning otherwise sustainable fiscal and corporate sector positions into unsustainable ones. In particular, we stress that the required change in relative prices is larger the more closed an economy is in terms of its supply of tradable goods. By contrasting Argentinas performance relative to other Latin American countries that were also subject to the Sudden Stop triggered by the Russian crisis of 1998, we identify key vulnerability indicators that separated Argentina from its piers. We also provide an explanation for the political maelstrom that ensued after the Sudden Stop, based on a War of Attrition argument related to the wealth redistribution conflict triggered by the Sudden Stop and fiscal collapse. This framework also provides elements to rationalize the banking crisis that accompanied the fall of Convertibility.

Systemic Sudden Stops: The Relevance Of Balance-Sheet Effects And Financial Integration

Using a sample of 110 developed and developing countries for the period 1990-2004, this paper analyzes the characteristics of systemic sudden stops (3S) in capital flows and the relevance of balance-sheet effects in the likelihood of their materialization. A small supply of tradable goods relative to their domestic absorption?a proxy for potential changes in the real exchange rate?and large foreign-exchange denominated debts towards the domestic banking system are claimed to be key determinants of the probability of 3S, producing a balancesheet effect with non-linear impacts on the probability of 3S. While financial integration is up to a point associated with a higher likelihood of 3S, beyond that point financial integration is associated with a lower likelihood of 3S.

Sudden Stops and Phoenix Miracles in Emerging Markets

A decade has passed since the salvos from Mexico’s Tequila Crisis of 1994–1995 echoed around the financial world. Since then, many more crises have taken place in emerging market economies (EMs). Furthermore, crises have tended to bunch together, bringing to the forefront the systemic nature of these events. True, every new crisis has its own idiosyncratic features, but useful policy lessons must be derived from robust, empirical regularities. This is the research strategy we have pursued in the last few years. We will report on two types of regularities that strike us as highly robust across EM crises: (a) Sudden Stops (of capital inflows) and (b) Phoenix Miracles. A Sudden Stop is a sharp fall in capital inflows relative to their past trajectory. Sudden Stops are not a common feature in developed economies and display a large degree of temporal bunching, suggesting that global capital market turmoil acts as a coordinating factor external to EMs. As shown in Section I, however, balance-sheet effects—namely, the interaction of large changes in the real exchange rate during Sudden Stops and Liability Dollarization (i.e., foreign-exchange-denominated debts)—are key in influencing the likelihood of a Sudden Stop. Thus, even though the initial shock is, in principle, exogenous to the economy, whether or not it materializes into a Sudden Stop depends on domestic financial vulnerabilities. On the other hand, a Phoenix Miracle is defined as a case in which output recovers relatively quickly from a sharp collapse with virtually no recovery in credit or capital inflows, and a very weak recovery in investment— hence the reference to the mythical bird “rising from the ashes.” The existence of phoenix-like recoveries suggests that financial frictions play a key role in pushing economies to the abyss from which, in some way or another, they can crawl back to safe ground by means less than apparent to the conventional observer looking for standard “fundamentals” and, thus, may appear miraculous. Interestingly, the Great Depression of the 1930s shares some of the key features of Phoenix Miracles in EMs, but shows salient differences as well that suggest nominal labor market rigidities are not crucial in explaining output collapse in EMs. Understanding these regularities could, and we believe does, shed light on policies aimed at preventing crises and attenuating their effects.

Booms and Busts in Latin America: The Role of External Factors

This paper analyzes the relevance of external factors in average quarterly GDP growth for 1990-2006 in the seven largest Latin American countries (LAC7). Modeling the relationship between LAC7 GDP and several external factors, it is found that those factors account for a significant share of variance in LAC7 GDP growth, and that external shocks produce significant responses. Likewise, a significant share of recent LAC7 growth performance can be explained by an external factor “tailwind. ” Also evaluated is the impact of deterioration in external financial conditions. Finally, the relevance of these findings for policy evaluation is emphasized. Growth performance, the strength or weakness of macroeconomic fundamentals and the impact of domestic macro and micro policies on growth can only be properly appraised by first filtering out the effects of external factors.

Real exchange rates, dollarization and industrial employment in Latin America

This paperuses a panel dataset on industrial employment and trade for 9 Latin American countries for which liability dollarization data at the industrial level is available. It tests whether real exchange rate fluctuations have a significant impact on employment, and analyze whether the impact varies with the degree of trade openness and liability dollarization. Econometric evidence supports the view that real exchange rate depreciations can impact employment growth positively, but this effect is reversed as liability dollarization increases. In industries with high liability dollarization, the overall impact of a real exchange rate depreciation can be negative.

Financial Integration and Foreign Banks in Latin America: How Do They Impact the Transmission of External Financial Shocks?

This paper explores the impact of international financial integration on credit markets in Latin America, using a cross-country dataset covering 17 countries between 1996 and 2008. It is found that financial integration amplifies the impact of international financial shocks on aggregate credit and interest rate fluctuations. Nonetheless, the net impact of integration on deepening credit markets dominates for the large majority of states of nature. The paper also uses a detailed bank-level dataset that covers more than 500 banks for a similar time period to explore the role of financial integrationcaptured through the participation of foreign banksin propagating external shocks. It is found that interest rates charged and loans supplied by foreign-owned banks respond more to external financial shocks than those supplied by domestically owned banks. This does not hold for all foreign banks. Spanish banks in the sample behave more like domestic banks and do not amplify the impact of foreign shocks on credit and interest rates.

Sudden Stops, the Real Exchange Rate and Fiscal Sustainability in Argentina

HE fall of convertibility in Argentina has stirred a lively discussion aboutthe causes for its collapse. Several explanations have been offered. Themost popular one relates to the unsustainable combination of a fixed exchangerate and large fiscal deficits that led to a rapid growth in public debt, severe fiscalproblems, and eventually, a loss of access to credit markets. Another popularview stresses the impact of devaluation by Argentina’s major trading partners asan important cause of real exchange rate (RER) misalignment, which reducedprofitability in the tradable sector. This, in turn, slowed down investment and ledthe economy into a protracted recession, with the associated deflation being themechanism for easing the RER disequilibrium.Here a different interpretation of the collapse of convertibility is provided,drawing heavily on recent work by Calvo et al. (2002). This interpretation shareswith the previous views the acknowledgement of fiscal sustainability problemsand RER misalignment. However, this view places special emphasis on financialconsiderations. In particular, it is argued that the impact of RER misalignmentwent beyond considerations of trade and competitiveness. It played a major rolein the fiscal and financial problems that eventually Argentina had to confront.Moreover, fixed exchange rates helped conceal those problems and, as a result,necessary fiscal measures were postponed, thereby intensifying the crisis.

Fiscal Sustainability in Emerging Market Countries with an Application to Ecuador

This paper surveys the recent literature on fiscal sustainability, with particular emphasis on emerging market countries. It discusses the main elements that differentiate emerging market countries from industrial countries and then discusses how probabilistic models can help to evaluate fiscal sustainability in an uncertain environment. Based on this discussion, the paper uses Ecuador to illustrate an application of the probabilistic model, and of the framework to evaluate the impact of shocks to current account financing on sustainability.

The Integrated Macroeconomic Model for Poverty Analysis: A Quantitative Macroeconomic Framework for the Analysis of Poverty Reduction Strategies

The authors present a dynamic, quantitative macroeconomic framework designed for analyzing the impact of adjustment policies and exogenous shocks on poverty and income distribution. They emphasize the role of labor market segmentation, urban informal activities, the impact of the composition of public expenditure on supply and demand, and credit market imperfections. Numerical simulations for a prototype low-income country highlight the importance of accounting for the various channels through which poverty alleviation programs and debt relief may ultimately affect the poor.

Scarring Recessions and Credit Constraints: Evidence from Colombian Plant Dynamics

Using a rich dataset of Colombian manufacturing establishments, we illustrate scarring effects of recessions operating through inefficient exit induced by heterogeneous credit constraints. We show that financially constrained businesses may be forced to exit the market during recessions even if they are more productive than surviving unconstrained counterparts: an unconstrained plant with TFP at the lowest 10th percentile faces the same estimated exit probability as a constrained plant with TFP at the 79th percentile. If credit constraints affect 1/3 of businesses, we estimate aggregate TFP losses of 1.2 log points after a four year long recession.