Friday, May 29, 2009

Latin America and the current global economic crisis

Latin America economies and its policy makers , are like the rest of the world trying to figuring out the way to minimize the losses arising from the current global financial crisis .Some countries are in a better institutional shape than others. According to a recent “Stress time competitiveness index “, the top of the list about this test, includes Denmanrk (which scores the maximum 100), Singapur (96,4) and Qatar(87,93) . Latin America economies scored heterogeneously on a three segment scale :The first segment includes :Chile,(67,79) Brazil (55,05), and PerĂº ( 44,39) .The second segment includes :Colombia (35,41)and Mexico(30,75), and the last segment includes Venezuela (0,0)and Argentina(0,04). Besides the competitiveness index 2009 results for Latin America economies , are concentrated in two groups : the one within places 21 and 40 :Brazil (40), Chile(25) and Peru(37) which has just signed a Free trade agreement with China, and the ones within places 41 to 57 which includes Mexico(46); Colombia(51) , Argentina(55) and Venezuela(57).-
There is an obvious relationships between the two measures. The Latin America economies best suited for coping with the effects of the crisis, are the one better qualified in terms of its competitiveness index. It follows that competitiveness as a goal for economic policy, pay off when it comes to confront severe fluctuations in global economies, like the current one underway ,because it means not only better tools and capabilities to overcome its effect, but a lower impact on welfare level than otherwise as well.
The welfare level, decrease during economic crisis because unemployment rise therefore income fall, and at the same time , firms have both human and financial capital losses which decrease investment . As a result, resources must be reallocated to a different and more efficient uses ,which imply a transaction cost because it take time to identify those new uses. The more flexible markets are ,the lower this adjustment (transaction cost ) and the faster the economy gets back its recovery path. Similarly, robust institutions and proper economic policy ,support a better prospect for economic recovery.
However in the current situation financial the weakness of banking system , make the whole process more complex. It is not only to get back on track the real sector , but also the financial sector as well , to make possible the economic recovery.
Thus ,those countries in a better shape, have better chances to adapt themselves quickly to this new environment , reducing the expected welfare losses and moving faster to he starting line for recovery.-
The traditional approach of both expansive fiscal and monetary policy, has been followed by all of this economies. However ,the impact will differ among them because of different scope , different structural conditions(mentioned above),and different amounts involved. Latin America economies even in a better shape than in the past (the eighties ) to solve this crisis ,will hardly avoid an economic contraction for this year. Some estimation (LAEC) expects a GDP contraction of more than .-0,3%, while others international institutions expect -1,5% or so for this year, given the further deterioration of mexican economy.Thus, no matter the implementation of policy prescription and good competitiveness , it is unlikely for Latin America economies to get positive economic growth this year.

Thursday, May 14, 2009

The meaning of economic crisis and free market economies

Part of the discussion about the current economic crisis ,is still based on upon who to blame for it. But the important issue goes beyond the one to keep accountable, it deals with the nature of free markets economies. Some Classical economists ,used to blame the capitalist accumulation behavior as a key source for business fluctuations and economic crisis, as long as it was based on credit expansion and its implications for higher interest rates. This has been known as the Austrian economic school of thought .On the other side, Keynes blamed the firm behavior which was production – instead of inventory driven. Thus, as soon as the market demand fell below expectations, firms were afraid to get higher than desired inventories ,therefore they decided to decrease production and unemployment increased.
The differences between both approaches, were in the implications. While in the first approach, crisis meant capitalism collapse and its substitution by a different economic model, in the second approach, government was called to save capitalism throughout active intervention in the economy ,using fiscal policy. It is obvious that in both cases ,the result is far from controversy. In fact ,it has been the controversy of more than a century.
What about the facts?: Private decisions deal with risk, which means uncertainty with a reasonable probability of control. In other words, it is in the roots of private firms and market economy ,the chance of failure .Individuals have within their DNA, even since fecundation , the seed for risky behavior .We learn either to walk, or to speak taking risks. There is no other way to understand human kind progress, without a comprehensive approach about risky decisions made by humans. The problem is that we usually do no count that much the number of success, as we do with the numbers of failures . Just to give a current example, the robot machine actually trapped in Mars ,is part of the risk of getting a better knowledge about that planet , the same way as it was the tragedy of the Challenger. But above all, every step backward ignite a stronger step forward. The free market economy is not different from that pattern.-
Markets seeks risk as the natural path for efficiency. The risk level, is a filter for a better (the best)use of scarce resources. Of course, it should be important to have a limit for those risk which becomes systemic ones , like those connected to the financial sector. However, no matter that limit, and technology progress free market economy, will always stay on the edge of risky options .
Thus, the policy option it is not to avoid risk, throughout heavy regulation ,but to prevent its consequences before it get beyond the maximum tolerance level. Institutions, become relevant to deal with the range of that tolerance as well, and proper policy instrument complement them.
So, who is to blame for the current crisis?. The blame for this crisis is also accountable for the greatest success of human kind. We all should learn there is no way that within a freedom framework, we can avoid the risk of failure. But that risk is worthy ,if we still can count on the second chance to fix it. Thus freedom justify itself , just because it mean an additional opportunity to try what it make the difference between wealth and poverty, between right and wrong.-

Friday, May 01, 2009

Central Bank role and the current global economic crisis (II)

An interesting paper “Financial Stability frameworks and the role of Central Banks: Lesson from the crisis” . Erlend W Nier IMF, april 2009 (Wp/09/70),explores quite accurately the implications for Central Banks about including the financial stability parameter within its policy reaction function.
So far, it is usual for Central Banks to consider within its policy reaction function ,only real parameters, leaving aside those which are connected with the financial side. Thus it might be the case that Central Banks actions ,goes in the opposite direction with financial innovation requirements . For this matter, whether Central Banks are going to be involved as the Lender of last resort(LOLR),it seems appropiate to improve its financial oversight of financial institutions, based on four considerations:
· Assessing solvency: Central Banks will be call to lend when the markets credit´s channels are not working because of long run uncertainty. The only way to get such a knowledge ,is throughout permanent supervision.-
· Gauging systemic impact: Access to supervisory information, allow Central Banks to have the ability for balancing the systemic impact that institutions under financial stress, might have.-
· Moral hazard arising from the safety net: Financial institutions might feel secure enough to go beyond the boundaries of long run systemic risk ,the market take into consideration. Thus ,there are strong incentives for moral hazard ,that the Central Bank is interest to regulate keeping close supervision about prudential liquidity levels.-
· Potential loss of credibility. Central Banks faces potential credibility cost from any mistakes handling the crisis. Thus It is not a “free lunch” path for Central Banks ,to go deeper on the financial root of such crisis. The risk of Failure, would impose high transaction cost for getting its message across to shape future market expectations. Therefore ,it is not only on Central Bank interest but ,on market interest as well, to have a better supervision and regulatory framework on systemically important institutions, for Central Bank to work on a prevention based approach.
It follows ,that Central Bank support for financial innovation goes hand by hand with a better and more active prudential regulation framework to the path such financial innovation might take. More so, when the Central Bank includes in its policy reaction function, the ratio of private debt/ GDP ,to decide to increase or not interest rate. As long as it has a better assessment of financial markets conditions, the better the quality of its judgment to decide the magnitude of interest rate changes, designed not just to get back prices stability , but also to protect financial innovation going on as an essential variable for long run economy growth .
Like any economic policy option, there are benefits and cost associated with this Central Bank closer to financial market .The main benefit ,comes from the lower output variability arising from stable financial conditions , and its lasting impact on welfare and efficiency. What about the cost ?. That is for another article.