In contrast, most of the discussion on fiscal policy in<sup>LAC deals just about</sup> long term sustainability issues, largely ignoring the effects of<sup>theeconomic</sup> cycle<sup>5</sup> . This is rather surprising as LAC economies are<sup>much morevolatilethan</sup> their European counterparts and have been generally applying procyclical<sup>fiscal</sup> policies that exacerbate volatility. Some analysts<sup>andpolicymakersappear to</sup> think that counter cyclical fiscal policies are a luxury that<sup>onlydeveloped</sup> countries can indulge in or, at least, that LAC countries<sup>(with theexception of</sup> Chile that has successfully put in place a counter cyclical fiscal policy)<sup>need to</sup> deal first with pressing adjustment and solvency<sup>issues beforethey attemptto</sup> reduce the highly procyclical character of their fiscal<sup>policies.</sup> In this paper I argue that this is a major mistake (in Section 2).<sup>First,</sup> because the costs of procyclical fiscal policies<sup>in LAC are hugein growth and</sup> welfare terms, specially for the poor. But, second,<sup>becauseprocyclical policies</sup> and rules tend to develop a deficit bias and thus end<sup>up being non sustainableand</sup> non credible. I then examine, in Section 3, the causes<sup>of the procyclicalityof</sup> fiscal policies in LAC. In Section 4 I discuss how<sup>welldesignedfiscal rules may</sup> help to deal with the political economy and credibility<sup>factors behind</sup> procyclicality of fiscal policies. Then, in Section 5, I examine<sup>conflictsbetween</sup> flexibility and credibility in rules, showing how<sup>a gooddesign may facilitatethe</sup> operation of automatic stabilizers, while at the<sup>same time supporting solvency</sup> goals and enhancing credibility. With these elements<sup>Isurvey in Section 6 the</sup> experience with different fiscal rules and institutions<sup>in LAC (Commodity</sup> Stabilization Funds, Fiscal Responsibility Laws,<sup>Stabilizing Transfers,the</sup> Chilean One percent Structural Surplus rule), analyzing<sup>to what extentthey have</sup> helped or can help to achieve the twin goals of avoiding<sup>deficitand procyclical</sup> biases. Finally, I conclude in Section 7 with a policy<sup>proposal, whichshould beof</sup> interest both for policymakers, market participants and<sup>International Financial</sup> Institutions.

# **2. WHY CARE ABOUT FISCAL PROCYCLICALITY?**

_A. Excess macroeconomic volatility in LAC reduces growth and_<sup>_is_</sup> _specially harmful for the poor._ Volatility has been since long a trademark of LAC's<sup>economic</sup> performance. By whatever measure, LAC economies<sup>havebeen more volatile</sup> than those of most other developed regions (see Figure<sup>16),and though LAC's</sup> volatility decreased during the nineties (Figure 2), after<sup>significantincreasesin the</sup> seventies and eighties, it remains twice as volatile<sup>as OECD countries,</sup>

> 5 With the major exception of IADB-based research:<sup>Gavin and Perotti (1996):"FiscalPolicyin Latin</sup> America: Volatility, Cyclicality and Modes of Adjustment,"<sup>OCE working paper,IADB; Gavin,M.,R.</sup> Hausmann, R. Perotti and E. Talvi (1996):"Managing<sup>Fiscal Policy in Latin Americaand the Caribbean:</sup> Volatility, Procyclicality, and Limited Creditworthiness,"<sup>OCE working paper,IADB.</sup>

> 6 Taken from "Securing Our Future in a Global Economy" by De Ferranti, D., G. Perry, I. Gill and L. Serven (2000), World Bank.

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