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KEYWORDS

E c onom ic gr o wth
E c onom ic c onditions
M a c r oec onom y
R a w m a ter ials
Pri c es

The macroeconomics of theLatin American economic boom

C a pital m ovem ents
I n t er na tional financ e
Fo r eign ex c hange r a tes

José Antonio Ocampo

E c onom ic policy
M o netar y policy
Fi sc al policy
E c onom ic s ta tis tic s
L a t in Am er ic aT

his paper argues that the recent boom in the Latin American

economies can be explained by the conjunction of two external factors
not found together since the 1970s: strong commodity prices (more sofor hydrocarbons and mining products than for agricultural commodities)
and exceptional external financing conditions. Concerning the latter, thekey development was the massive influx of capital during two periods of“exuberance” in international financial markets (between mid-2004 and April
2006, and between mid-2006 and mid-2007), particularly the second. It also
argues for the importance of spreading and consolidating Latin America’s
two great (and complementary) macroeconomic policy innovations ofrecent years: countercyclical fiscal management (still confined to just a few
countries) and active intervention in currency markets. Such intervention
needs to be based on a growing recognition that the real exchange rate
ought to be an explicit goal of macroeconomic policy.

José Antonio Ocampo
Professor at Columbia University,
Former Executive Secretary of ECLAC✒✒ jao2128@columbia.edu

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I
Introduction
In 2007, Latin America will have had four consecutive
years of rapid growth (ECLAC, 2007a). There has notbeen a period of such strong economic expansion in theregion since the long post-war boom that culminated in
the debt crisis (or a few years earlier in some countries).
This situation has come, furthermore, after almost a quarterof a century of unsatisfactory performance marked by
the “lost decade” of the 1980s, the “lost half-decade” of
1998-2002 and a period of weak performance between the
two. What is more, the current situation is characterized
by a combination of rapid growth and a large current
account surplus that is exceptional in Latin America’s
economic history, as well as by improved labour market,
poverty and income distribution. The countries have also
adopted a more explicit policy of intervening in currency

markets and increasing their external assets, while thetendency to follow procyclical macroeconomic policies
has been corrected to some extent. So far, however,progress with the latter has been largely confined tojust a few countries.
This paper analyses the current macroeconomic
situation and seeks to identify its particular characteristics. After examining the main macroeconomic
results and their relationship with world economic
conditions (section II), it looks more closely at theeffects of movements in international financial markets (section III), analyses macroeconomic policy
developments in the region’s seven largest economies(section IV) and ends with some brief conclusions(section V).

II
The current situation and the international context
In the past few years, Latin America has at last returned to the economic growth rates of the 1970s. Given
that the two largest Latin American economies (Brazil
and Mexico) have performed less well now than they
did then, the indicators look even better when simple
averages of GDP growth in the region’s countries arecompared. If that is done, the situation now is an improvement on the 1970s. Furthermore, since the rate of
population increase has fallen sharply, the results lookeven more impressive when calculated in terms of percapita output growth.
The explanation for this is basically to be sought in
the exceptional conditions prevailing in the international

A version of this paper was presented at the fourth economic forumof the Getulio Vargas Foundation on 17 September 2007. The author is
grateful to Rudy Loo-Kung, Julio Marichal, Mariangela Parra, Helvia
Velloso and Jürgen Weller for providing the necessary statisticalinformation. Discussions with Guillermo Calvo and Osvaldo Kacef
helped to clarify some of the ideas dealt with here.

economy over the last few years.1 Although, as we shallsee later, some aspects of macroeconomic management
have been more effective than in the past, this is notnecessarily something that contributes to short-term
growth. Indeed, it is possible that the countercyclicalmacroeconomic policies the Latin American countries
have begun adopting, albeit very unevenly, might actually
be sacrificing current demand growth to an improved
ability to deal with adverse economic conditions infuture. Nor can the improvement in performance beattributed to economic reforms, whose effects on the
production structure and economic growth have beenmuch debated and may actually have been more negative than positive.2 From a Schumpeterian perspectiveof “creative destruction”, however, it might perhaps

1 See the recent essay by Izquierdo, Romero and Talvi (2007).
2 For an ambivalent assessment from a perspective that is generally

favourable to the reforms, see Kuczynski and Williamson (2003). A
more critical evaluation can be found in Ocampo (2004).

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

CEPALREVIEW93

be said that the reform-led phase of destruction in the
countries’ production capacity is now over, and thatwhat should prevail from now on are rather the factors
favouring the creation of new export capabilities. The
absence or weakness of productive development policies, however, is still one of the main shortcomings of
economic policy in the region.
The current boom is basically due, then, to the
conjunction of two favourable factors of external origin
not seen together since the 1970s: strong commodity
prices and exceptional external financing conditions.
The economic history of Latin America shows that thiscombination leads infallibly to rapid economic growth.
In the current circumstances, however, the transmission
mechanisms for external financing have been somewhat
different, mainly because governments have been far
more circumspect in their use of such financing.
To these two favourable factors must be added athird: large remittances by Latin American migrants totheir home countries. This factor has had a large effecton the economies that are closest geographically to
the United States and, interestingly enough, has been
particularly important in most of the small economies
whose terms of trade have deteriorated in recent years
because of high oil prices. Meanwhile, the boom in international trade has boosted growth in the manufactured
goods and services exports on which the region (andespecially the economies of Mexico, Central America
and the Caribbean) increasingly depends.
It should be added that the external situation is
also exceptional in another way: this is the first period
in global economic history when per capita GDP has
grown much faster in the developing countries than in
the industrialized world, i.e., the first reversal of thetendency in global economic history for developmentlevels in the two sets of countries to diverge (United
Nations, 2006). However, it is still too soon to speak oftrue long-term convergence in these levels, except in thecase of some Asian economies. Moreover, the current
boom has encompassed every region of the developingworld and, among them, Latin America has been in fact
the weakest performer (United Nations, 2007).
The factors giving rise to this exceptional performance are well known. High raw material prices aremainly due to the heavy dependence of the Chinese
economy on commodity imports. Exceptional financing conditions, in turn, reflect a wide array of factors:(i) the tolerance of the monetary authorities in the world’s
leading economies for low interest rates, owing to low
inflation levels; (ii) major financial innovations that,combined with the search for higher returns, multiplied•

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2007

9the demand for and liquidity of riskier financial instruments; (iii) the consequent large reduction in the risk
premiums of such securities, and (iv) the large build-up
of developing countries’ international reserves, owing
to the saving of exceptional foreign exchange surpluses
and the demand for “self-insurance” that arose after
the Asian crisis, when it became clear that there was
no international mechanism for dealing with crises
caused by sudden stops in external financing. Some ofthese conditions, particularly the second, are changing.
Rising remittances, meanwhile, reflect growing movements of labour (both regular and irregular) from Latin
America to the industrialized countries, partly becauseof very limited job creation in the region during the“lost half-decade”.
Figure 1 shows the long-term rise in commodity
prices, taking the 1945-1980 period as the base. As it
illustrates, this has been much less exceptional than isusually thought. Indeed, the drop in real prices for nonoil commodities in the 1980s and 1990s has yet to bereversed. In addition, the process has been very uneven,benefiting mining products more than agricultural ones.
In real terms (deflated by a manufacturing price index),
metal prices in 2006 stood 76% above the 1945-1980
average, an extraordinary level surpassed only in a few
years in the early twentieth century. Conversely, prices
for tropical and temperate zone agricultural products
in 2006 were still 41% and 29%, respectively, below
their 1945-1980 levels; some of these prices have risen
in 2007, however, because of the biofuels boom. Pricerises for oil and gas have come on top of those for mining
products, although the oil price only very recently roseback to its 1970s level in real terms. Thus, the recent
commodity price boom involves hydrocarbons andmining products more than agricultural commodities.
It is still too soon to speak of long-term improvements
in real prices reversing the downward trend in non-oil
commodity prices seen over the twentieth century(Ocampo and Parra, 2003).
Among the factors helping Latin America’s current
account balance over recent years, the dominant one has
been the improvement in its terms of trade, amounting to
the equivalent of 3.4% of gross domestic product (GDP)for the region as a whole between 2003 and 2006 (table 1).
Some of these gains were automatically taken out inthe form of profit remittances by foreign firms activein mining sectors. However, while this effect has been
large in some countries, for the region as a whole thefactor income balance trend has improved marginally as
net production factor payments and the cost of foreign
debt have fallen relative to GDP. Meanwhile, migrants’

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figure 1

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Real commodity price index(1945-1980=100)
200
180
160
140
120
100
80
60
40
20
0

1971-1980

1981-1990

Non-oil commodities

1991-2000

2004

Tropical agriculture

2005
Other agriculture

2006
Metals

Source: Original data from Ocampo and Parra (2003), updated with individual product information from the United Nations Conference on
Trade and Development (UNCTAD).

remittances, which improved the balance of payments by
0.9% of GDP between 2000 and 2003, have not made amajor additional contribution in recent years, although
they are still a major source of income for some of theregion’s smaller economies.
The fact is that, in net terms, the greatest contributor
to the balance of payments after the improvement in theterms of trade has been increased net financial flows,a reflection once again of their markedly procyclicalcharacter. This tendency also contrasts with that of net
foreign direct investment, reflecting the twofold effectof lower investment in Latin America and the expansionof Latin American firms abroad.
The relative importance of financial flows andimproved terms of trade is better observed if the
Bolivarian Republic of Venezuela is excluded fromthe calculations, as the country has experienced thegreatest terms-of-trade gains while its capital account isdominated by official capital flows. As table 1 shows,when the Venezuelan economy is excluded from thecalculations, the improvement in the terms of trade
between 2003 and 2006 falls to 2.5 points of GDP
while the increase in financial flows rises to 1.7 points.
Furthermore, the importance of external financing wasparticularly marked during the phases of “exuberance”
in international financial markets, as will be seen in
section III of this paper.

The most striking new feature of the current situation is the region’s ability to grow quickly while at thesame time generating a current account surplus, and thus
a net transfer of resources abroad. This combination,
characteristic of the dynamic economies of East Asia,
is unprecedented in the region’s history. As figure 2
shows, the closest parallel is with the situation of the
1950s and 1960s, when Latin America combined growthwith small current account surpluses (or small deficits,
if the Bolivarian Republic of Venezuela is excluded).
In the 1970s, the region kept on growing rapidly but
became dependent on net transfers of resources fromabroad, and the same happened when economic growthresumed, but more slowly, in 1990-1997. As is wellknown, the great volatility of financial flows meant that
depending on external resources for growth ultimately
proved counterproductive on both occasions.
Does this mean we are on the verge of a shift towards
long-term economic growth with current account surpluses, as in many of the most successful economies ofEast Asia? The answer, sadly, is no. The most importantachievement in the current situation has been the improvement in the region’s external borrowing position(figure 3, panel A). Combined with the debt reduction
processes of recent years, this means that the pressureof large external debts will be felt less in future or, to beaccurate, will be felt in a smaller group of countries.

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Latin America and the Caribbean: Factors underlying the improvementin the balance of payments(Percentages of gross domestic product in current dollars)
1998

1999

2000

2001

2002

2003

2004

2005

2006

2000
versus1998

2003
versus2000

2006
versus2003

A. All Latin America and Caribbean
Current account balance   Terms of trade effect   Discounting terms of trade effect

–4.4
–1.3
–3.0

–3.0
–1.0
–2.1

–2.4
0.0
–2.4

–2.8
–0.7
–2.1

–1.0
–0.7
–0.2

0.4
–0.3
0.7

1.0
0.8
0.2

1.4
1.8
–0.4

1.6
3.0
–1.4

2.0
1.3
0.6

2.8
–0.3
3.1

1.2
3.4
–2.2

Foreign direct investment
Financial capital

3.0
0.4

4.4
–2.1

3.6
–0.4

3.4
–1.5

2.7
–3.2

2.1
–1.9

2.3
–2.6

2.1
–1.2

1.1
–0.6

0.5
–0.8

–1.5
–1.5

–1.0
1.3

Overall balance

–0.9

–0.7

0.8

–0.8

–1.5

0.6

0.7

2.3

2.1

1.7

–0.2

1.5

Memo: Transfers

0.9

1.1

1.1

1.4

1.7

2.0

2.1

2.0

2.1

0.2

0.9

0.0

B. Excluding Venezuela (B.R.)
Current account balance   Terms of trade effect   Discounting terms of trade effect

–4.4
–0.5
–3.8

–3.3
–0.4
–2.9

–3.2
0.0
–3.2

–3.1
–0.4
–2.6

–1.5
–0.5
–0.9

–0.2
–0.3
0.1

0.3
0.6
–0.3

0.4
1.1
–0.7

0.7
2.2
–1.4

1.2
0.5
0.6

2.9
–0.3
3.2

0.9
2.5
–1.5

Foreign direct investment
Financial capital

3.0
0.6

4.6
–2.0

3.6
0.1

3.5
–1.2

2.9
–2.7

2.1
–1.6

2.4
–2.1

2.1
–0.3

1.2
0.1

0.6
–0.5

–1.4
–1.7

–0.9
1.7

Overall balance

–0.8

–0.8

0.5

–0.7

–1.3

0.3

0.6

2.3

2.1

1.3

–0.2

1.8

Source: Author’s calculations based on ECLAC statistics.

FIGURE 2

Latin America and the Caribbean: Relationship between the goods
and services balance and economic growth(Percentages)

Real GDP growth rate6

1971-1980

1961-19705

2004-2006

1951-1960
1991-1997

4
3
2
1

1998-2003

0
–2.0

–1.5

–1.0

1981-1990

–0.5

0.0

0.5

1.0

1.5

2.0

2.5

Goods and services balance as % of GDP
Latin America and Caribbean

Excl. Venezuela (B.R.)

Source: Author’s calculations based on ECLAC statistics.

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Conversely, the current account surplus has two
important characteristics that undermine its positiveeffect. First, it is largely confined to just seven countries, five of them oil or mineral producers (Bolivia,
Chile, Ecuador, Peru and the Bolivarian Republicof Venezuela) and two with more diversified export
structures (Argentina and Brazil). Of the latter, Brazil’s
current account could move into deficit in the near
future. Second, when adjusted for the improvementin the terms of trade, the current account has been in

FIGURE 3•

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deficit since 2005 and is deteriorating rapidly, whichmeans that deficits in 2007 will be very similar to thoseof 2000-2001 (figure 3, panel B). The conjunction ofthese two factors indicates that the current accountsurplus is heavily dependent on the boom in international hydrocarbon and mineral prices. Therefore, theimprovement in the current account should be viewed
with the caution recommended by Calvo and Talvi(2007) rather than with the optimism that is common
among other observers. Indeed, the calculations of

Latin America: External debt and the current accountA. External debt as % of GDP
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0

1998

1999

2000

2001

External debt

2002

2003

2004

2005

2006

External debt net of reserves

B. Current account, adjusted and unadjusted for the terms of trade, as % of GDP
2.0
1.0
0.0

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

1.0
2.0
3.0
4.0
5.0
Current account balance

Adjusted for terms of trade

Source: Author’s calculations based on data from ECLAC (2007a).

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those authors are much more unfavourable than thoseshown in figure 3, panel B.3
The above analysis indicates, then, that the situationof rapid growth with large current account surpluses isunlikely to continue in future and that the region’s balanceof payments depends heavily on exceptional international
prices for hydrocarbons and minerals. Although it is not
impossible that this situation may persist if the Chinese
economy continues its rapid expansion, the lesson from the•

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2007

13

region’s economic history is that it is perilous to assume
that high commodity prices will be permanent. Again,
the severe turmoil in international financial markets inthe third quarter of 2007 reminds us that this other sourceof the current boom – exceptional external financing
conditions – may also weaken as time goes on. This iscompounded, of course, by the uncertainty surrounding
economic growth around the world, and especially in the
United States, as a result of these events.

III
The effects of international
financial movement
Although commodity prices have recently played adecisive role in the macroeconomic dynamics of Latin
America, the international financial markets have also
had a major influence. The nature of financial flows haschanged and so, consequently, have the transmission
mechanisms. Indeed, every boom has its own specificfeatures: in the 1970s, inflows derived essentially fromlending by groups of banks (“syndicated loans”), but
in the 1990s they came mainly from international bondissues.
The nature of recent financial flows can be better
appreciated from the external balance sheets shown intable 2. This table, which covers the seven largest Latin
American economies, reveals two striking changes. The
first is the increase in assets, particularly international
reserves but also direct and portfolio investments abroad,which in all cases grew by even more than these seveneconomies’ GDP in current dollars (which itself rose by
65% between 2003 and 2006). The second is the large
shift in the composition of liabilities, essentially driven
by the reduction in borrowing and the rise of securities
portfolio liabilities. The latter include investments inboth the share and bond markets of the region’s countries
by international investment funds. The counterpart tothis shift in assets and liabilities, therefore, has been
the boom in both domestic bond markets (table 2) andstock markets.

3 See also ECLAC (2006, pp. 20-21).

There are two further features of this balance sheetthat are worth highlighting. First, net external liabilities
have fallen sharply: by some 10 percentage points of
GDP between 2003 and 2006, mostly in the net financial position. This is true, furthermore, for six of theseven largest Latin American economies (the exception
is Mexico). Three of them (Argentina, Chile and the
Bolivarian Republic of Venezuela) now have a positive
net financial position. Again, the reserves build-up looks
extremely sound when compared with debt liabilities,
but much less so if the comparison is with all portfolio
liabilities. One way of looking at it, and this will becomemuch clearer later, is that the build-up of reserves has
been matched by a rise in portfolio liabilities. Indeed,
reserves in the region’s two largest countries only covera fairly small proportion of portfolio liabilities, while inthree countries (especially Mexico, but also Chile andPeru, albeit from a much sounder position), reserves
have increased by less than these liabilities.
Figure 4, panel A, shows how exceptional the recent
international financial situation has been. Emerging
market risk spreads began to narrow dramatically in thelast quarter of 2002; since the second half of 2004 they
have been systematically lower than they were the year
before the Asian crisis, and since mid-2005 they have been
lower than those of high-risk bonds in the United Statesmarket. Latin America was something of a latecomer tothis process, but has improved by more than the average
since 2004. Thus, the second half of 2004 appears tomark the beginning of the “exuberance” in international
financial markets (to use the term coined by the former

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Latin America (seven largest economies):a External balance sheet(Percentages of gross domestic product at current prices)
2001

2002

2003

2004

2005

2006

27.6
6.0
2.2
0.0
12.6
6.8

31.1
7.3
2.5
0.0
13.9
7.5

33.4
7.3
3.3
0.0
14.0
8.7

33.1
7.5
3.4
0.1
13.2
8.9

32.8
7.3
3.6
0.0
11.9
9.9

34.3
8.0
4.2
0.0
11.5
10.6

64.9
25.5
20.6
5.7
14.8
0.0
18.8

68.5
26.7
21.0
5.1
15.9
0.0
20.7

73.6
29.9
24.2
7.5
16.6
0.0
19.5

69.6
29.4
24.0
8.8
15.2
0.1
16.1

64.1
27.9
23.7
10.9
12.8
0.1
12.4

63.8
27.1
25.2
13.7
11.5
0.2
11.3

AssetsTotalbOutward direct investment
Portfolio holdings
Derivatives
Other investments
International reservesb
Liabilities

TotalaForeign direct investment
Portfolio holdings   Stocks   Debt
Derivatives
Other investmentsb

Assets - liabilities

Direct investment
Financial

Reserves as % of debt

–37.3

–37.4

–40.2

–36.6

–31.4

–29.6

–19.5
–17.8

–19.4
–17.9

–22.6
–17.6

–21.9
–14.7

–20.6
–10.8

–19.1
–10.5

20.3

20.4

24.0

28.3

39.1

46.5

Reserves as % of portfolio liabilities

33.1

35.5

35.9

37.0

41.6

42.1

Domestic bond market as % of GDP

33.6

32.6

40.3

40.6

46.0

51.8

Financial assets - liabilities
Argentina
BrazilChile
Colombia
MexicoPeru
Venezuela (B.R.)

–0.3
–34.9
–3.2
–15.6
–19.3
–29.4
23.9

19.8
–36.4
–1.5
–15.6
–18.3
–27.7
35.9

20.1
–35.2
3.9
–16.8
–20.4
–26.4
48.7

22.0
–31.0
13.5
–11.8
–20.4
–21.3
44.6

29.5
–24.1
17.2
–6.1
–21.3
–14.4
49.5

26.2
–24.3
27.7
–3.7
–23.8
–7.5
51.6

Reserves as % of portfolio liabilities
Argentina
BrazilChile
Colombia
MexicoPeru
Venezuela (B.R.)

2.2
18.1
142.4
78.8
30.8
131.1
113.5

–14.2
13.1
145.8
88.1
41.6
125.4
93.8

1.7
13.6
108.3
84.2
42.7
105.2
111.4

19.6
15.7
98.9
91.8
39.0
114.4
109.4

67.6
23.1
93.3
102.7
35.8
91.7
123.9

72.8
28.6
98.3
96.8
30.0
98.2
161.7

Source: Author’s estimates based on imf International Financial Statistics, GDP in current dollars as per ECLAC data. Bank for International
Settlements for domestic bond market data.
a Argentina, Brazil, Chile, Colombia, Mexico, Peru and the Bolivarian Republic of Venezuela.
b The value of liabilities with the International Monetary Fund (imf) is deducted from these accounts.etario Internacional (fmi).

President of the United States Federal Reserve, Alan
Greenspan) in relation to developing countries. As table
3 shows, if that period is taken as the starting point for
the recent financial boom, the risk spreads of the sevenlargest economies in the region diminished appreciably
in most cases and only moderately in the two countries
that were already considered low-risk before the boom
(Chile and Mexico).

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The fall in spreads has considerably outstripped
the rise in long-term reference interest rates: thoseof United States Treasury bonds. In fact, long-term
interest rates on these bonds have increased only very
moderately since the Federal Reserve began raising its
rates in September 2004. Thus, the cost of long-term

FIGURE 4•

DECEMBER

15

2007

external financing has fallen by almost as much as Latin
American risk spreads. On average, meanwhile, the dropin spreads has roughly matched the rise in the shortestterm United States interest rates, so that in this case thenet effect has been more varied: while the drop in risk
spreads has tended to predominate in Brazil, Colombia

Latin America: Risk spreads and stock markets
A. Emerging-market risk spreads and United States high-risk bonds(Basis points)
1 200
1 000
800
600
400
0

jan/00
apr/00
jul/00
oct/00
jan/01
apr/01
jul/01
oct/01
jan/02
apr/02
jul/02oct/02
jan/03
apr/03
jul/03
oct/03
jan/04
apr/04
jul/04oct/04
jan/05
apr/05
jul/05
oct/05
jan/06
apr/06
jul/06
oct/06
jan/07
apr/07
jul/07200

EMBI

High-risk bonds

EMBI average for 12 months before Asian crisis

B. Dollar index of Latin American stock markets(July 2003-June 2004=100)
450
400
350
300
250
200
150
100

Stock market index
Source: JP Morgan Chase for spreads and risk, Morgan Stanley for stock market indices.

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

jun-07

sep-07

dec-06
mar-07

jun-06

sep-06dec-05
mar-06

jun-05

sep-05dec-04

mar-05jun-04

sep-04dec-03
mar-04jun-03

sep-03dec-02
mar-03jun-02

sep-02

dec-01

mar-02

jun-01

sep-01

dec-00

mar-01

jun-00

sep-000

mar-00

50

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Latin America (seven largest economies): Changes in risk spreads and share prices

Latin
America

Argentina Brazil Chile Colombia Mexico

Peru

Venezuela(B. R.)

Non-Latin
3
Americamonths
EMBI

UnitedStatesinterest
rates
1 year10 years

A. EMBI Globala (change in basis points)
Jul 04-abr 06
Apr-jun 06
Jun-dec 06
Dec 06-jun 07
Jun-aug 07

–362
37
–51
16
53

–4 680
71
–169
109
125

–375
37
–62
–30
35

–2
5
1
–1
24

–278
82
–78
–42
78

–66
19
–39
–4
20

–219
–3
–84
–1
49

–417
59
–43
171
125

–147
41
–39
1
53

323
22
2
–21
–77

277
31
–21
–9
–72

57
5
–41
32
–49

Apr 06-aug 07

55

136

–20

29

40

–4

–39

312

56

–74

–71

–53

Jul 04-aug 07–307–4 544

–395

27

–238

–70

–258

–105

–91

249

206

4

B. Share prices (percentage change in dollar terms)
Jul 00-jul 04
Jul 04-apr 06

5.7
140.9

–42.4
222.3

–13.4
176.1

22.9
63.8

188.1
277.5

22.1
113.2

99.5
82.3

7.0
21.0

Apr-jun 06
Jun-dec 06
Dec 06-jun 07
Jun-aug 07

–10.7
26.5
25.3
–5.8

–12.9
24.7
3.4
–4.5

–11.2
21.1
29.6
–4.9

–8.9
27.6
26.7
–6.1

–30.2
39.1
9.9
–6.7

–9.4
36.5
18.5
–8.2

–3.1
23.5
62.3
1.2

–3.3
15.9
2.6
–1.8

Abr 06-aug 07

33.4

7.2

32.5

38.4

–0.6

34.6

96.4

12.8

<Jul 04-aug 07

221.5

245.6

265.9 126.7

275.4

187.0

257.9

36.5

Source: JP Morgan Chase for spreads, Morgan Stanley for stock market indices, Federal Reserve data for United States interest rates.
a EMBI: Emerging Markets Bond Index.

and Peru, low initial spreads in Chile and Mexico meanthat these countries have faced upward pressure on parshort-term interest rates (table 3).4
The exuberance in the financial markets wastransmitted to the Latin American economies throughthree different channels. First, the reduction of country
risk spreads created direct pressure for lower domestic
interest rates. A second and sometimes complementary development was that this pressure fed through toexchange rates. Growing foreign investment in localcurrency stock and bond markets thus began to create anever-closer link between domestic and external markets,
potentially affecting both interest and exchange rates;

4 The cut-off date for table 3 is August 2007. It therefore excludes

developments subsequent to the Federal Reserve interest rate cuts of
mid-September, which triggered a new upsurge whose duration andintensity were not yet clear at the time this essay was completed.

furthermore, these effects could be multiplied by thederivatives markets. Third, the strong risk appetite characterizing this situation was reflected in investments inthe domestic capital markets of the region’s countries,
which generated asset inflation in stock markets. As
figure 4, panel B indicates, the beginning of the great
Latin American stock market boom coincided with thestart of the rapid fall in the region’s risk spreads.
The two periods of turmoil in international financial
markets in recent years also left a clear mark on thisprocess. The first, in April and May 2006, originatedin emerging markets (especially China), while that oflate July and early August 2007 had its epicentre in the
United States. The Latin American economies wereaffected by contagion in both cases. This is reflected
above all in the high correlation between the average risk
spread of emerging markets and the exchange rates of
the region’s seven largest economies in the two periodsof upheaval, with the exception of Peru in both periods

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

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Latin America (seven largest economies):
Volatility of risk spreads and exchange rates during two periods of turbulence
Argentina

BrazilChile

Colombia

MexicoPeru

Venezuela(B.R.)

embi+a16.4
25.0

Spread volatilityb
May-July 2006
July-September 2007

26.2
60.6

19.6
21.9

3.6
14.5

27.7
31.6

14.7
15.0

10.1
23.5

20.9
64.6

Exchange-rate volatilityc
May-July 2006
July-September 2007

0.56%
0.78%

3.24%
2.95%

2.11%
0.91%

3.12%
4.51%

1.81%
1.21%

0.57%
0.57%

2.24%

Correlation between exchange rate and EMBI+
0.789
0.832
May-July 2006
0.818
0.658
July-September 2007

0.796
0.364

0.885
0.789

0.755
0.930

–0.388
0.059

0.477

Source: Estimated on the basis of information from JP Morgan Chase.
abc

EMBI+: index of high-risk emerging-market bonds.
Standard deviation, expressed in basis points.
Coefficient of variation (standard deviation expressed as % of the mean).

and, to some extent, of Chile in the most recent one;this correlation does not affect the Bolivarian Republicof Venezuela, which has had a fixed exchange rate since2005 (table 4).
Among the region’s largest countries, the one mostaffected in country risk terms during the first phase of
upheaval was Colombia, followed by Argentina. However,exchange-rate volatility had the greatest effects in Brazil
and Colombia.5 All stock exchanges saw price falls. The
combined effect of lower share prices and a depreciating
peso was very marked in Colombia, whose stock market
fell by 30% if share prices are measured in dollars(table 3). With hindsight, we now know that the appetite for risk in international markets remained strong,turning this financial collapse into a mere ripple in the
upward trend of stock markets (figure 4, section B). Risk
spreads were back to normal by the end of the year andthe downward trend in spreads became perceptible again
in the first half of 2007, except in the cases of Argentina
and the Bolivarian Republic of Venezuela. There began
to be a perception that these two countries were affectedby a type of risk that may perhaps be most appropriately

defined, in the terminology of the markets, as “political” (Ecuador, which does not appear in the table, had
experienced something similar in 2006).
The “flight to quality” which characterized the crisisof July-August 2007 had a larger impact on high-risk
securities in the United States market than on emerging
markets (figure 4, panel A).6 This time, in fact, themain mechanism of contagion was the liquidation of
investors’ positions in emerging markets to cover losses
or liquidity needs in the markets of the United Statesand other industrialized countries. Among the largest
Latin American nations, Argentina, Colombia and the
Bolivarian Republic of Venezuela were most affectedby rising risk spreads, and Brazil and Colombia once
again by exchange-rate volatility. Chile and Mexico,along with Colombia, were the countries where theimpact on stock markets was greatest (table 3). An
interesting feature of a crisis that had its epicentre in
the United States market is that the “flight to quality”
has been reflected in rising prices for Treasury bonds,
and interest rates for all terms have tended to fall as aresult, with the shortest-term rates also being forced
downward by the decision of the Federal Reserve to cut

5 In the case of Colombia, the exchange-rate volatility of recent times(the highest of any Latin American economy) stands in contrast to
the first half of the present decade, when volatility was normal byinternational standards. See Banco de la República (2007).

6 See ECLAC (2007b) for an analysis of the effects of this crisis on

Latin America.

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the discount rate on 17 August and the federal funds rateon 18 September. Indeed, these cuts in reference rates
were greater than the rise in the risk spreads of several
Latin American countries, so that their par interest rates
actually fell slightly during the crisis.
Although the debate about the implications of therecent financial market shock on economic growth in
the United States and the world continues, the crisis had
what may be a lasting effect on the behaviour of financial
agents. Some developments in the United States overthe last few months are very familiar to Latin Americancountries and the developing world from their own crises.
Some examples are: the widening contagion of a problem
that arose in one segment which everyone believed tosuffer from problems specific to that segment rather
than being more widely spread, the illiquidity of highrisk securities and debts, the lack of information about
portfolio quality, and the “flight to quality” by all agents,
including the main financial intermediaries. In any event,the market euphoria that followed the 18 September cut
in the discount and federal funds rates was also reflectedby the surge in Latin American stock markets, making
the stock market turmoil of July and August look evenmore insignificant than that of the second quarter of 2006
(figure 4, panel B). The appreciating tendency of Latin
American currencies had begun before 18 September
and temporarily accelerated after that date.
One controversial issue has been the effect of fluctuations in international financial markets on the exchange
rates of the Latin American countries. Machinea and Kacef(2007) prepared an analysis according to which changes
in the real exchange rates of the Latin American countries(calculated as the ratio between real exchange rates in2005 and the average for the 1990s) reflect the pressuresfrom improvements in the terms of trade and the rise inremittances from Latin American workers abroad, rather thanphenomena associated with the capital account. However,this analysis, valid if the 1990s are taken as the point ofcomparison, does not explain the dynamics of exchange
rates during the recent boom or the strong upward pressure
in real terms on the currencies of Brazil and Colombia,
the two countries in Latin America where this tendency
has been most striking in the last three years and where
exchange-rate volatility has been greatest during periodsof turmoil in the international financial markets.
As figure 5 shows, there is no systematic relationshipbetween improving terms of trade and movements inreal exchange rates since 2004, a period that coincides
with the commodity price boom. The chart bears thisout. Among the larger countries, the great improvementin the terms of trade may have been responsible for the•

DECEMBER

2007

real appreciation of the Chilean peso at an early stage,or of the Venezuelan bolívar more recently (although
this currency does not show any real appreciation during
the 2003-2006 period as a whole). But improved termsof trade certainly do not account for the large appreciation that the Brazilian and Colombian currencies haveexperienced in real terms.
As figure 6 confirms, the dynamics of exchange rates
in these last two countries is unequivocally associatedwith fluctuations in private-sector financial flows. Bothcountries had experienced a large devaluation in the third
quarter of 2002, coinciding with rising emerging-market
risk spreads (figure 4, panel A). In the case of Brazil
this was also associated with market speculation duringthat year’s presidential elections. The exchange rate in
Brazil strengthened and stabilized in the first half of 2003
while in Colombia it appreciated more gradually, but
by mid-2004 neither of the two countries had returnedto the levels of the first half of 2002.
Strong currency appreciation in Brazil and Colombia
over recent years has exactly coincided with the twophases of exuberance in international financial markets,
the first of which can be situated, on the basis of the preceding analysis, between mid-2004 and April 2006, andthe second between mid-2006 and mid-2007. Currency
appreciation in both countries during these periods wasclearly associated with capital flows, as is shown by the
behaviour of net portfolio flows in the case of Brazil andnet private-sector capital inflows in Colombia’s foreignexchange balance (i.e., flows involving movements of liquid
resources). In the case of Brazil, net portfolio flows had
averaged US$ 44 million a month in the four years prior
to the first of these booms (i.e., between July 2000 andJune 2004), rising to US$ 309 million a month between
July 2004 and April 2006. In the case of Colombia, net
inflows in the private-sector foreign exchange balance
averaged US$ 232 million a month during this first phaseof exuberance, having been slightly negative between July
2000 and June 2004. In both cases, the combination oflarger inflows of short-term capital and lower risk spreads
resulted in a large appreciation of the local currency. The
central banks of both countries began intervening in thecurrency markets during this period but, as we shall see
later, only to a modest extent.
The episode of April-May 2006 led to an outflow ofcapital from Colombia that had a considerable impact on
net capital flows, exchange rates and, as we have seen,
the stock market. The outflow of short-term capital was
also large in Brazil, but the effects were smaller. Capitalbegan to flow in again in the second half of 2006, andthe flow became an avalanche in the first half of 2007,

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

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Latin America (16 countries): Relationship between improved terms of tradeand real currency appreciation, 2003-2006

Real currency depreciation (+) or appreciation (-)

20%
10%

CRI
HND
NIC

–20%
URY

SLV

BOL
ARG

PER

MEX

0%
0%

PRY

ECU

VEN

20%

40%

60%

80%

100%

–10%

GTM

COL

CHL

–20%
–30%
BRA

–40%

Change in terms of trade

Source: Author’s calculations based on data from ECLAC (2007).

when net private-sector capital inflows through the capital
accounts reached US$ 4,011 million a month in Brazil
and US$ 751 million in Colombia, i.e., multiples of theamounts entering in the first period of market exuberance.
Indeed, as figure 6 shows, the size of the capital inflow
has been so much greater than the amounts normallyreceived by these countries that it can only be explainedby speculation based on the belief that their central banks
will have to let their currencies appreciate. Continuing
high interest rates in Brazil and the clear expectationthat overheating in the economy would force Colombia’s
Banco de la República to raise rates, as indeed it had
been doing since the second half of 2006, explains why
this seemed like a “sure bet” to speculators. This is on
top of the relative fiscal weakness of the two countries
and the fact that, as we have seen, both have experienced
a large reduction in country risk spreads.
The central banks of Brazil and Colombia intervened
massively during the second episode of financial market
exuberance, increasing their international reserves by justover US$ 61 billion and US$ 6.1 billion, respectively, inthe first half of 2007. This intervention did not prevent
both countries’ currencies from appreciating further,
however. In May, Colombia also reintroduced a legal
reserve requirement of 40% for incoming financial capital,a mechanism that had been successfully employed during
the boom in capital flows of the 1990s. The introductionof the reserve requirement resulted in a fall in net capital
inflows in June (i.e., before the United States financial crisis
became apparent), indicating that it had some effect.
The recent shock in international financial markets
led to a fresh reversal of these tendencies, and the effects
were felt much more strongly once again in Colombia.
Indeed, while the Colombian peso shed a great deal of
the strength it had gained in the first half of 2007, thesame did not happen with the Brazilian real. It was thesetwo countries, furthermore, that saw their currencies
appreciate most from mid-September onward as a resultof the new market euphoria generated by the decisionsof the Federal Reserve.
The rise in private capital flows during the two
periods of exuberance in international financial markets
was a more general phenomenon, however, as the capital
accounts of the main Latin American countries indicate.
Figure 7 compares aggregate current account balanceswith capital account balances for six of the region’s
seven largest economies (the Bolivarian Republic ofVenezuela is excluded for the reasons set out in section
II of this paper). Capital account balances, which werevirtually nil between mid-2002 and mid-2004, recovered
and began to outstrip those of the current account as asource of surpluses in the balance of payments. Afterthe shock which hit the markets in the second quarterof 2006, capital inflows swelled enormously during the

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FIGURE 6

Brazil and Colombia: Exchange rates, portfolio flows and capital flows
A. Brazil: exchange rate and net portfolio flows
7 000

4June 2004

6 000
5 000

3.5

4 000
3 000

3

2 000
1 000

2.5

0
–1 0002–2 000Exchange rate

05-2007

01-2007

09-2006

05-2006

01-2006

09-2005

05-2005

01-2005

09-2004

05-2004

01-2004

09-200305-2003

01-2003

09-200205-2002

01-2002

09-200105-2001

01-2001

09-2000

05-2000

1.5

01-2000–3 000–4 000

Portfolio flows (3-month average)

B. Colombia: exchange rate and private capital through foreign exchange balance
3 100

1 400

June 2004

1 200

2 900

1 000

2 700

800

2 500

600

2 300

400
2 100

200
05/2007

01/2007

09/2006

05/2006

01/2006

09/2005

05/2005

01/2005

09/2004

05/2004

01/2004

09/2003

05/2003

01/2003

09/200205/2002

01/2002

09/2001

05/2001

01/2001

09/2000

05/2000

–200

1 900
01/2000

0

1 700
1 500

–400
Private capital flows (3-month average)

Exchange rate

Source: Central Bank of Brazil and Banco de la República, de Colombia.

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

CEPALREVIEW93•

second period of exuberance. The figures are telling: inthe six countries considered, the balance-of-payments
surplus during the last quarter of 2006 and the first half of2007 was some US$ 113 billion dollars, of which about
US$ 100 billion came from the capital account (roughly
two thirds went to Brazil and the remainder to the otherfive economies). As we shall see in the following section,
the currency authorities reacted correctly to this recent
avalanche of capital, building up international reserves
on a scale unprecedented in the region’s history.

FIGURE 7

DECEMBER

21

2007

There can be no doubt, then, that while other phenomena have been influencing the currency markets,
speculative capital flows have been a factor and indeed
have played a crucial role in the two countries that
seemed the surest bet to speculators. One consequenceof this is that the large international reserves currently
held by Latin America are offset by a large amount ofpotentially reversible capital, particularly in the casesof Brazil and Colombia. The high degree of correlation
between exchange rates and risk spreads during the twomarket shocks that have followed the two phases of
euphoria also bear out this interpretation.

Latin America (six countries):a Current account and capital account balance
50 00040 00030 000
20 000T1 2007

T3 2006

T1 2006

T3 2005

T1 2005

T3 2004

T1 2004

T3 2003

T1 2003

T3 2002

T1 2002

T3 2001

T1 2001

T3 2000

T1 2000

T3 1999

T1 1999

T3 1998

T1 1998

T3 1997

T1 1997–10 000

T3 19960

T1 1996

10 000–20 000–30 000

Current account

Capital account

Capital (3-quarter average)

Source: Author’s estimates based on data from IMF, International Financial Statistics, updated with information from the countries’ central
banks. In the case of Chile, funds accumulated in the stabilization funds are deemed equivalent to reserves.
a

Argentina, Brazil, Chile, Colombia, Mexico and Peru.

IV
Changes in macroeconomic policy
The history of the last few decades in Latin America has
been marked by procyclical macroeconomic policies
that have boosted economic growth during periodsof external buoyancy but built up vulnerabilities thatmake themselves felt when these exceptional external
conditions come to an end.
The economic reforms of the last few years haveaffected the cyclical behaviour of the Latin American

economies in three different ways. First, liberalizationof the capital account has reduced the scope for independent management of monetary and exchange-rate
policy; efforts to prevent appreciation during upturns
result in a loss of freedom to adopt countercyclicalmonetary policies, while non-intervention in the currency market can mean a high degree of exchange-rate
volatility. Second, the combination of capital market

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liberalization and domestic financial liberalization has
reinforced the operation of the financial accelerator,
which tends to increase lending, asset inflation andprivate expenditure during upturns only for the opposite
to occur in downturns. Third, the increased incomeelasticity of short-term import demand has made thecurrent account more sensitive to the business cycle:
the conjunction of higher demand growth and realcurrency appreciation results in a rapid deteriorationof the current account during upturns, but this is also
corrected more quickly during crises. Of these threemechanisms, only the last could be considered to havesome countercyclical effects, insofar as the domestic
effects of the procyclical behaviour of private spending
are thereby smoothed. But the price for this is that it
also contributes to these economies’ external vulnerability during upturns.
An interesting corollary of the cyclical behaviourof economies subject to procyclical inflows of externalfinancing is that the “twin deficit” of current accountvariations is the private-sector balance, not the publicsector one. This can be clearly seen in figure 8: the large
current account adjustment experienced by the Latin
American economy between 1998 and 2003 resulted
from an improvement in the private-sector balance; thedeterioration in the current account over the last three
years, when adjusted for the terms of trade, is the resultof a deterioration in that same balance. This also seems
to be a general characteristic of “successful” countries
during upturns, as Marfán (2005) points out.
In this context, and in very open economies generally, it can be said that the only really autonomouspolicy instrument available to the economic authorities
is fiscal policy. According to economic theory, this isalso the most powerful instrument for affecting economic activity in economies whose capital markets
have been liberalized. However, fiscal policy has also
been subject to procyclical behaviour, for two different reasons. The first is the direct effect generated by
the availability of resources, whether tax revenues orfinancing: the abundance of resources during upturns
tends to increase public spending, while lower revenues,
combined with the higher cost of debt servicing, leadto cuts in primary spending during crises. The second
concerns political pressures on economic policymaking: after a period of public spending cutbacks, it
is hard to convince the population of the virtues of acontinuing programme of austerity. This is even truer
if the justification for the austerity programme during•

DECEMBER

2007

the upturn is the need to offset the exuberance of private
spending (Marfán, 2005).
Analysis of the most recent Latin American cycle
confirms the procyclical behaviour of private and public
expenditure and of the monetary and credit variables,with some interesting variants. In economies with net
foreign-currency liabilities, the tendency towards currency
appreciation during upturns generates positive wealth effects
which help to boost private demand.7 As already noted,
the most important countercyclical element is the large
rise in imports resulting from high income-elasticity andreal currency appreciation, which shift a large portion ofdemand abroad. Thus, the effects of real appreciation on
the current account are countercyclical, unlike wealtheffects. The behaviour of imports does, however, produce a rapid deterioration in the balance-of-payments
current account, helping to create the conditions for the
next downturn. The main “twin deficit” of the current
account is the private deficit, as we have seen, but inthe Latin American countries it has been common for
public-sector deficits to increase at the same time.
Once the downturn has started, the most importantdevelopment is the collapse of private spending, although
the effects of this on aggregate demand are smoothedby the even faster decline in imports. During this phase,currency depreciation once again has a procyclical wealtheffect (the loss of wealth associated with net liabilities
denominated in foreign currencies) that contributes to thecontraction of demand. It also sets up a countercyclicaleffect that operates through the balance-of-payments
current account but takes time to make itself felt fully inthe economy, partly because of the financial shocks thatcharacterize the initial phase of the downturn. Monetaryand credit policy also has procyclical effects to begin
with, either because the authorities try to smooth the
inflationary effects of depreciation by measures suchas higher interest rates or credit restraint, or both, or
simply because private-sector credit collapses while
higher country risk spreads place pressure on domestic
interest rates.

7

Note that when net financial balances turn positive, as they have
now done in three of the region’s seven largest economies, this wealtheffect becomes countercyclical in relation to the economy as a whole.
To ascertain whether the argument remains valid, however, it would benecessary to calculate the net financial balance of the private sector.
In most cases, it is the public sector that has built up a positive net
financial balance (this is even true of Brazil, whose net financialbalance is still negative).

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

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Latin America: “Twin” surpluses and deficits(Percentages of gross domestic product at current prices)
0.04
0.03
0.02
0.01
0

1998

1999

2000

2001

2002

2003

2004

2005

2006

–0.01
–0.02
–0.03
–0.04
–0.05
Current account balance

Adjusted current accountPrivate-sector balance

Source: Author’s calculations based on data from ECLAC (2007).

The most important countercyclical factor operating
initially in several Latin American economies has been
public spending, which tends to hold up or even increase
when a crisis breaks. As the fiscal accounts deteriorate,
however, financing constraints are brought in, leading
to measures to correct the deficit, either by increasing
revenue or by reducing expenditure. Meanwhile, currency
depreciation begins to have ever stronger countercyclicaleffects on the balance-of-payments current account,
while the large depreciation that has built up in real terms
allows the authorities concerned to loosen monetary
policy. The countercyclical role played by these two
factors is vital during the recovery phase and relieves
fiscal policy of this task to some degree.
Generally speaking (although there are variations from one country to another), the Latin Americancountries were in the initial adjustment phase during
the 1998-2001 period, passing to the second phase in
2002-2003. The first phase was characterized by a rapid
correction of private-sector deficits and, in some cases,
a deterioration in the fiscal accounts; in the second, on
the other hand, the public accounts tended to do better
while those of the private sector improved yet further.
In practice, the private-sector deficit for the region as awhole (estimated rather crudely by deducting the central
government balance from the current account balance)

was corrected in 1999, even as the public-sector deficit
continued to worsen (as shown by the gap between the
two lines in figure 8); then in 2002 the budget deficit
began to shrink (very slowly), while the private-sector
surplus increased yet further.
In this context, what new developments havethere been in Latin America during the recent upturn?
As figure 8 shows, in the region as a whole the upturn
has served to correct the budget deficit left over fromthe downturn. The private-sector accounts, on the other
hand, have followed the pattern typical of previous upturns by starting to deteriorate, although they are still in
surplus. Naturally, the calculations would alter if in eachcase we were to discount the gain of a little over three
percentage points of GDP in the terms of trade; in theprivate sector, particularly, this would mean discounting
the effect of the upturn on foreign firms operating in
the hydrocarbon and mining sectors, where prices haverisen most sharply.
The first great difference from the past seems to lie,then, in fiscal management. However, the story is rather
less favourable than the aggregate figures suggest. Table
5 shows what has happened with primary spending by thecentral government in the seven largest Latin Americancountries. Strictly countercyclical fiscal management
during upturns requires not only that extraordinary

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fiscal revenue be saved, but also that primary spending
be reduced as a proportion of GDP, as this expenditure
should follow the long-term trend of GDP growth. On
this definition, only Chile and Peru have followed countercyclical fiscal policies, underpinned in Chile by theredesign of the country’s stabilization funds (Economic
and Social Stabilization Fund and Pension Reserve
Fund, since 2006) and in Peru by legally binding limits
on primary spending increases; in this latter case, therules concerned, which were changed in 2006, imply
that public-sector investment in Peru will not be subject
to these constraints in future, so that the countercyclicaleffect will wear off. The other countries in table 5 haveoperated procyclical fiscal policies, most strikingly inthe case of the Bolivarian Republic of Venezuela. In thecases of Brazil and Mexico, it could perhaps be argued
that the continuing weakness of economic growth makesa more expansionary fiscal policy advisable, while higher
spending in Brazil might be justified by the fact that thecountry is running a large primary surplus. The first ofthese arguments has some merit. The second is clearlywrong: fiscal policy is procyclical in this case even if
the public accounts yield a primary surplus.
The generally procyclical fiscal policy that continued
to be applied in some countries during the recent upturnis at odds, of course, with the complex institutional
apparatus created in the late 1990s, when numerous
fiscal responsibility laws were passed and stabilization
funds established. Rule changes and the earmarking ofresources indicate that these institutions have had only
a limited impact so far (Jiménez and Tromben, 2006).
Again, the combined effect of the current upturn andhigher prices for hydrocarbons and mining products has
had as its corollary that countries with an export base ofthis type are generally the ones to have benefited most interms of public revenue (Jiménez and Tromben, 2006).
This is what has happened, most particularly, in Chileand the Bolivarian Republic of Venezuela (and Bolivia
among the smaller countries)8 and, to a lesser extent,in Colombia and Peru. The effect has been strengthened by a rising tax burden on these sectors, especiallyin Bolivia, Ecuador and the Bolivarian Republic ofVenezuela in the case of hydrocarbons and Chile in thecase of copper (special tax on the operating revenuesof mining companies). In the case of Argentina, it must
be recalled that the country strengthened its tax base8 This is not the case with Ecuador, since the country is using muchof its additional oil surplus to subsidize domestic fuel consumption.

•

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2007

at the beginning of the upturn by appropriating someof the benefits accruing to certain commodities fromreal exchange rate depreciation by means of so-called“retentions” on exports; in 2007 it did much the samething, only this time by appropriating part of the increase
in international commodity prices.
The second major new development is the frequency
and scale of official intervention in the currency markets,reflected in the build-up of external assets by central
banks and, in the case of Chile, by the government infiscal stabilization funds. This means that the leading
Latin American economies (with the exception of the
Bolivarian Republic of Venezuela since 2005) generally
operate a “dirty” float (with variants, as will be seen later).
Thus, the countries have usually opted for “intermediate”
managed exchange-rate regimes, running counter to theorthodox recommendation of adopting one of the two
extremes: either a free float or a fixed parity (1990s
Argentine-style convertibility or dollarization). What
this suggests is that there is an implicit exchange-ratetarget. The benefits of exchange-rate targets have been
analysed theoretically9 and their use can be justified
in the light of Latin American economic history. The
only explicit policy of this type is the one adopted by
Argentina, where the maintenance of a competitive
exchange rate is one of the cornerstones of macroeconomic policy. Indeed, the Argentine experience showsthat, in situations where external financing is abundant,
it is possible to exercise control over the exchange rateand interest rates simultaneously even with a liberalized
capital account, which runs completely counter to thefamous open economy “trilemma” (Frenkel, 2007).
As is very well known, a policy of this type requiresthat the build-up of international reserves during upturns be matched by measures to sterilize their monetaryimpact. Sterilization of this type is easier when there
is a fiscal surplus. Otherwise (and as an additional
measure in any event) it will be necessary to sterilize
via a mix of traditional open market operations, salesof central bank-issued bonds in the market, or higher
reserve requirements.
For this reason, in the Argentine model the fiscal
surplus is an essential complement to the policy ofmaintaining a highly competitive exchange rate; thepossible erosion of this surplus, if public spending
continues its recent rate of increase, is a threat to themacroeconomic policy model adopted by Argentina.

9 See Williamson (2000), for example.

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2007

Latin America (seven largest economies): Monetary, credit and fiscal policy indicators(Percentages)
Argentina

BrazilPeru

Venezuela(B.R.)

Chile

Colombia

Mexico

2.4

5.2

2.2

0.6

2.5

6.7

0.7

2.1

–2.5

1.4

1.3

–0.5

4.9

0.6

–0.2

7.7

1.0

–0.7

3.0

1.8

2.7
1.0

2.1
–3.1

8.4
7.7

–0.3
–4.4

0.1
–2.0

3.2
1.4

2.1
0.0

3.5

–4.8
–8.1

4.0
2.3

2.5
–0.5

0.8
0.7

2.5
2.0

–8.0

–2.9
–1.7
–5.4
–4.0

6.3
8.3
10.1
9.4

–0.1
0.9
0.9
1.7

0.6
1.8
1.9
1.9

–1.4
–1.9
–0.5
–0.3

0.8
–1.2
1.0
1.2

–10.6
–7.5
–3.7
–3.0

–0.1
1.9
2.6
2.3

0.9
1.1
10.0
7.3

0.3
0.6
–7.8
1.6

1.2
1.7
5.0
10.7

0.5
0.9
5.8
3.7

1.0
1.8
1.1
–3.0

3.4

A. Change in central government fiscal accounts as % of GDP, 2003-2006
Current revenuesa

1.2

Primary spending
Primary balance

B. Central government fiscal balance, 2006
Primary balance
Total balance
C. Change in nominal interest rate, 2003-2006
Policyb
Interbank
D. Real interest rate (deposits)
2003
2004
2005
2006
E. Change in balances as % of GDP, 2003-2006
Monetary base
M1
M3
Lending to the private sector

8.7
3.9

Source: ECLAC for fiscal statistics, imf International Financial Statistics for interest rates and monetary and credit variables (except in the caseof the Bolivarian Republic of Venezuela, where they were estimated from ECLAC figures), JP Morgan Chase for basic policy rates.
a Total revenues in the case of Brazil and Mexico.
b Between June 2004 and September 2007. The equivalent rate for the United States rose by 3.75%.

Precisely the opposite situation is found in Brazil andColombia, since these two countries still have the largest
overall fiscal deficits; this factor has unquestionably
made them more vulnerable to currency speculation.
Mexico has opted for a cleaner float. The same could
be said of Chile, which operates a clean float from theexchange-rate policy standpoint, but whose government
intervenes massively in the currency markets throughthe stabilization funds.
Figure 9 shows the scale of official intervention in thecurrency markets of six countries during the two phasesof market exuberance discussed earlier, from July 2004
to April 2006 and from July 2006 to June 2007. In bothcases, intervention included the accumulation of reserves,the use of these reserves to pay off IMF debts and, in thecase of Chile, the build-up of stabilization funds abroad.
For the sake of comparability, interventions have been
calculated as an annual equivalent (the second period did

actually last a year) and as a proportion of GDP. It can beseen that intervention took place on a large scale. This wasparticularly true of Argentina in the first period, followed
by Peru and Brazil. In the second period, intervention
was massive in Argentina, Brazil and Chile and very highin Colombia and Peru. In all cases, it far exceeded thecurrent account surplus (Colombia is the only country of
the five to run a current account deficit), indicating thatit also absorbed surpluses from private-sector capital
flows. Of the region’s seven largest countries, Mexico isthe only one where official intervention in the currency
market has been limited.
Monetary and credit policies are very difficult
to compare. Although national situations vary, all thecountries had slightly or markedly procyclical monetary and credit policies during the recent upturn. Thisis reflected in basic intervention rates, which haverisen by less than United States Federal Reserve rates

The macroeconomics of the Latin American economic boom • José Antonio Ocampo

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Figure 9

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Latin America (six countries):
Official intervention in currency markets, two periods(Percentages of gross domestic product)

9
8
7
6
5
4
3
2
1
0
–1

Argentina

BrazilChile

Colombia

MexicoPeru–2
July 2004-April 2006

July 2006-June 2007

Source: Estimates based on changes in reserves as given by IMF International Financial Statistics. In the case of Chile, the later period includes
resources saved in the Economic and Social Stabilization Fund and Pension Reserve Fund. Nominal dollar GDP is the average for 2004 and 2005
in the first period and the 2006 figure in the second. Reserves accumulated in the first period are calculated as a 12-month average equivalent.

(except in Chile, where it is slightly higher), and canbe seen even more clearly in interbank rates (table 5).
With the striking exception of Brazil (where real interest
rates are still extremely high despite a large reduction
in nominal rates), deposit rates have remained at very
low levels in real terms (they were negative in threeof the seven countries in 2006). In addition, with few
exceptions, monetary and credit aggregates have risen
as a proportion of GDP. The table shows two worrying
cases of very rapid growth in financial system lending to
the private sector: these are Brazil and Colombia, and it
is no coincidence that they are the two countries where
capital inflows have increased most dramatically. The
Bolivarian Republic of Venezuela also displays clearly
expansionary monetary and credit indicators.
One favourable trend on the monetary and credit
front has been the “de-dollarization” of different countries
in recent years. The most widespread development has
been the tendency for foreign currency-denominatedpublic-sector liabilities issued in local capital markets
to dwindle or disappear. Argentina conducted a radical
de-dollarization of its financial system during the crisisof the early part of the decade, and Peru has adopted apolicy of gradual de-dollarization (together with Bolivia
and Uruguay, among smaller countries).

Taking everything together, one of the mostinteresting conclusions from the analysis is that themacroeconomic policy challenges facing the region’s
main economies are highly diverse (although we areconcentrating on the macroeconomic challenges, weare obviously aware that there are other major economic
challenges, not least the need to diversify the production
structure and, in certain countries, energy problems).
Chile is in the soundest position, thanks to a successful
countercyclical fiscal policy; this might be said to havegone too far in 2006, with the result that growth was
relatively slow, but the situation has now been remedied.
Peru is the country that most resembles Chile where
fiscal policy is concerned. Argentina has also had avery successfully macroeconomic policy, grounded in
a competitive currency and a fiscal surplus; if the recent
upward trend in public spending is maintained, however,the second of these pillars will be eroded. Along with the
Bolivarian Republic of Venezuela, furthermore, Argentina
is the country with the highest inflation rate.
Exchange-rate competitiveness and the rapid growthof domestic credit are the main problems facing Brazil
and Colombia, and their most obvious result is the deterioration of the current account, which is well advanced
in Colombia and could materialize soon in Brazil. The
combination of a more austere fiscal policy, monetary

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CEPALREVIEW93

and prudential measures to check credit growth andgreater intervention in the currency markets (including
the reserve requirement for external financing adopted
by Colombia in May 2007) may be the right answer. As
long as these measures are applied, Brazil’s high interest
rates will continue to be a magnet for outside capital.
Mexico, meanwhile, can be seen as an intermediate casein all the aspects analysed; its main problems concern
competitiveness. This being so, it would not be illogicalfor this country to join the South American (and Asian)•

DECEMBER

2007

27

trend towards more active exchange-rate management
as part of its economic policy.
The Bolivarian Republic of Venezuela, lastly, has
the most expansionary fiscal policy, while monetaryand credit policy is also procyclical. Of the region’slargest countries, therefore, it is the only one still engaging in patterns of macroeconomic behaviour thatwere widespread in Latin America in the past and thatwill be sustainable only if conditions in the oil market
remain exceptional.

V
Conclusions
The analysis carried out here points to three conclusions. The first is that the region has already reaped
considerable benefits by using the current commodity
price boom as an opportunity to reduce external liabilities and build up international reserves. The build-up
of reserves looks less impressive, however, when set
against the concomitant increase in portfolio liabilities,
whose essential characteristic during the recent upturn
has been the increased quantity of resources invested byinternational investment funds in local stock and bondmarkets. At the same time, the current account, adjusted
for the terms of trade, is deteriorating, and this will ultimately remove the most striking feature of the recent
situation: the conjunction of a current account surplus
with rapid economic growth. This combination, then,has its origin in an exceptional surge in hydrocarbon andmining product prices (more than agricultural prices)and does not reflect, as in East Asia, a high degree ofinternational competitiveness.
The second conclusion is that we should remainaware of the potential of the international financial
markets to deliver shocks like those occurring in avariety of forms over the past few years. The largest
one was the massive influx of capital into the region’slarger countries during the two periods of exuberance
in international financial markets (between mid-2004
and April 2006, and between mid-2006 and mid-2007),particularly the second. In the two countries most sensitive
to this phenomenon, Brazil and Colombia, the massive
inflow of capital was reflected in the rapid growth offinancial system lending to the private sector and excessive appreciation of the local currencies, the risks ofwhich are now beginning to become clear. Insofar as thesource of the disruption is the exuberance of financial

markets, it is worth adopting preventive measures tocheck the inflow of capital. Chile and Colombia used
these successfully in the 1990s. Colombia also adopted
measures of this type during the recent boom, although
only once the influx of capital and the appreciation of
the currency had reached a very advanced stage.
Lastly, the two major (and complementary) macroeconomic policy developments that have occurredin Latin America in recent years need to be consolidated and applied more widely: countercyclical fiscal
management, pioneered by Chile and to a lesser extent
by Peru, and active currency market intervention, withthe build-up of international reserves that this entails.
The leading example of this latter policy is Argentina,
where events have also underscored the complementary
relationship between exchange-rate competitiveness andthe maintenance of a fiscal surplus (although this risks
being eroded because of the expansionary fiscal policy
followed recently).
Where there is active intervention in currency
markets, it may be worth acknowledging that the realexchange rate is a legitimate goal of macroeconomic
policy, something that tends to be implicit rather than
explicit in all countries but Argentina. The absence ofan effective curb on currency appreciation can becomea magnet for capital inflows in periods when privatesector agents are expecting this to occur. Brazil andColombia have been obvious victims of the influx ofspeculative capital seeking to take advantage of theseexchange-rate trends. There is an obvious risk in all
the countries, but especially these two, that the flows
may be reversed.
For this reason, it would not be illogical to movetowards an asymmetrical currency regime designed to

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compensate for the asymmetry affecting developing
countries in the international capital markets, i.e., easy
access in upturns and inadequate access in downturns. This
regime would establish an exchange-rate ceiling (which
could take the form of a crawling peg during upturns),
but would allow currencies to float during downturns.
The international reserves accumulated during upturns•

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2007

would be used to intervene in currency markets during
downturns to achieve an orderly exchange-rate adjustment
and such other goals as the authorities may set themselves, particularly in relation to interest rates. The reserves
build-up during upturns obviously needs to be properly
sterilized, something that is easier to do if there is a fiscal
surplus, i.e., a countercyclical fiscal policy.
(Original Spanish)

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The macroeconomics of the Latin American economic boom • José Antonio Ocampo