significantly more volatile than South Asia and slightly more volatile than East Asia in terms of volatility of real GDP growth. The picture is roughly the same when macroeconomic performance is measured by aggregate consumption or spending.

Economic instability can affect growth through different channels. Most of the existing empirical evidence shows that this impact is generally negative. Serven (1998) finds<sup>7</sup> that all of his five alternative definitions of economic instability -measured by the volatility of innovations to macroeconomic variables such as inflation, terms of trade, real exchange rate, growth rate and price of capital goods- are strongly negatively correlated with investment ratios. High volatility also tend to skew investment towards short run gains in a non-optimal way. Destruction of firms and banks informational and organizational capital during deep recessions have long lasting effects, as Stiglitz has pointed out. There 8 can also be irreversible human capital losses, as indicated in the last WB WDR . This findings were corroborated for LAC by an IADB report<sup>9</sup> , which found not only statistical evidence of a significantly negative effect of macro volatility on long term growth in the region, but also of a perverse relation between volatility and poverty, education, income distribution and financial deepening.

High volatility is indeed specially harmful for the poor. The poor have less human capital to adapt to downturns in labor markets. They have less assets and access to credit to facilitate consumption smoothing. There may be irreversible losses in nutrition and educational levels if there are no appropriate safety nets, as is usually the case in LAC (see below). It should not come as a surprise, then, that we find an asymmetric behavior of poverty levels during deep cycles: poverty levels increase sharply in deep recessions and do not come back to previous levels as output recovers (WB WDR<sup>1</sup> ).

_B. Procyclical fiscal policies may exacerbate macro volatility in LAC_ In our year 2000 Flagship publication at the Bank"<sup>1</sup> , we estimated the causes of excess volatility in LAC, taking volatility in OECD and East Asian countries as a benchmark. We found that nearly 1/3 was due to exogenous shocks (TOT are more volatile in LAC due to concentration in a few commodity exports; capital flows are also more volatile -though not as much as usually thought-); 1/3 to insufficient financial integration and development of domestic financial markets and 1/3 to volatility in macro policies (both fiscal and monetary). See figure 3. The importance of volatile monetary policies has been reduced overtime, but that is not the case with fiscal policies. Though the study does not identify the

> 7 Serven, L. (1998):"Macroeconomic Uncertainty and Private Investment in LDCs: An Empirical Investigation," World Bank working paper, September.

> 8 World Bank (2000):"Attacking Poverty," World Development Report 2000/2001.

> 9 "Hacia una Economfa Menos Volatil (Apendice tecnico)," Progreso Econ6mico y Social en America Latina, Informe 1995, Banco Interamericano de Desarrollo. 0World Bank (2000) op. cit.

> De Ferranti et al. (2000) op. cit.

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