Transcript Monetary Policy with Head Winds: Issues and Trade-offs

LAC Success Put to the Test
Presentation at Central Bank of Peru
Lima, 15 Agosto 2011
Chief Economist Office
Latin America and the Caribbean
The World Bank
1
Structure of the presentation
 LAC’s success and the maturing recovery – real decoupling



The new face of LAC after a good decade
Maturing (decoupled) recovery cycle
Domestic policy tensions
 Rising global uncertainty and risks – financial coupling



European ailments: are sovereign debt troubles reaching the core?
U.S. downgraded: is a double-dip in the horizon?
China: how hard a landing?
 Whither LAC?


Can LAC avoid the traditional boom-bust pattern and achieve a high
trend growth (real trend decoupling)?
How resistant is LAC macro-financial immune system to a potential
downward cyclical re-coupling on a global scale?
2
LAC’s Success and the Maturing Recovery
3
LAC’s success
Non-inflationary growth decoupling from rich countries
Cyclical-adjusted Growth in Latin America and High-Income Countries
Trend growth computed using the band-pass filter
7%
High-Income
Latin America
6%
5%
4%
3%
2%
1%
0%
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
The trend growth of real GDP growth is computed using the band-pass filter (Baxter and King, 1999). LCRCE staff calculations. Source: WDI
– World Bank; National Authorities.
4
LAC’s success
Reduction in poverty and income inequality
Gini Coefficient Cumulative Change
From 2009 to 1995
Per Capita GDP Growth and Poverty
LAC Countries
45
Costa Rica
40
Dominican Republic
Colombia
9,000
8,000
35
7,000
30
6,000
5,000
25
Poverty Headcount
GDP Per Capita
2010
2008
2006
2004
2002
2000
1998
1996
Honduras
Bolivia
Chile
El Salvador
Argentina
Panama
Latin America
Mexico
Brazil
3,000
1994
20
4,000
Uruguay
GDP Per Capita
US Dollars
Moderate Poverty Rate
US$ 4 a Day
10,000
Peru
Paraguay
-0.1
-0.05
0
Source: LCSPP based on Socio-Economic Database for Latin America and the Caribbean (CEDLAS and The World Bank).
0.05
0.1
5
LAC’s success
An expanding middle class
Source: LAC Chief Economist Office, World Bank.
6
LAC’s success
Stellar performance during the 2009 global downturn
Growth in Real GDP
Middle Income Countries
Previous Cycles
Current Cycle
Previous Cycles
T+6
T+5
T+4
T+3
T+2
T+1
T
T-1
T-2
T-3
T-4
T-5
T+6
T+5
-0.16
T+4
-0.16
T+3
-0.12
T+2
-0.12
T+1
-0.08
T
-0.08
T-1
-0.04
T-2
-0.04
T-3
0.00
T-4
0.00
T-5
0.04
T-6
0.04
T-6
Growth in Real GDP
Latin America and the Caribbean
Current Cycle
LAC came out of the global crisis without balance sheet damage
Notes: The figures represent the deviations from regional/group trend growth in real GDP on 13-quarter windows centered on previous and current
troughs on real GDP. This figure depicts the behavior of real GDP in previous and current recession-recovery cycles. Sources: IMF’s International Financial
Statistics – IFS, National Statistical Institutes and Central Banks, Haver Analytics.
7
LAC’s success
Joining the dynamic EMs in the recovery phase
World Industrial Production
Index Apr-08 = 100
120
115
 Emerging economies
with strongest recoveries
include Brazil, China,
India, Korea, Malaysia,
Philippines and Thailand
Crisis
Advanced Economies
Emerging Economies
110
105
100
95
 They represent 52% of
emerging economies’ GDP
90
85
Apr-11
Sep-10
Feb-10
Jul-09
Dec-08
May-08
Oct-07
Mar-07
Aug-06
Jan-06
80
Note: The group of developed countries refers to OECD countries excluding Turkey, Mexico, Republic of Korea, and Central European
countries. Source: CPB (Netherlands Bureau for Economic Policy Analysis).
8
LAC’s success
Joining the dynamic EMs in the recovery phase
Contribution to World Economic GDP
as a % of World GDP increase (PPP)
100%
80%
42%
55%
65%
60%
Emerging
economies
40%
Advanced
economies
58%
45%
20%
35%
0%
1996-2001
2001-2006
2009-2011
Note: This graph use the WEO definition of Emerging Economies and Advanced Economies. For the “2009-2011” window we use the last
WEO’s forecast (April – 2011)
9
LAC’s uneven success
Mutating regional heterogeneity
Slow-Growth Countries within LAC
Medium-Growth Countries within LAC
GDP Index 2002 = 100
170
160
GDP Index 2002 = 100
170
Actual
Potential
Actual
Potential
160
150
150
140
140
130
2011
2010
2009
2008
2007
2006
2005
2004
2002
2011
2010
2009
2008
2007
2006
90
2005
100
90
2004
100
2003
110
2002
120
110
2003
130
120
High-Growth Countries within LAC
GDP Index 2002 = 100
170
Actual
Potential
160
150
140
130
120
110
100
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
90
Sources: Potential GPD is computed as the average rate of growth between 2007 and 2003. Simple averages are used to construct the composite. The categorization of
each group is as follow: Slow-growth are those countries that showed a less than 3.5% in their 2011-2008 GDP real growth rate; Medium-growth are those between 3.5%
and 10%: High-growth are those with 10% or more. For 2011 we used the last available forecast (Consensus Forecast June-2011). Sources: Consensus Forecast (June –
2011); WEO (April – 2011).
10
LAC’s uneven success
Where you are matters less than to whom you are connected
Cumulative
Low growth
Medium growth
High growth
Total
Number of
countries
Mean growth
2003-2007*
Mean Growth
2003-2011
Mean Growth
2008-2011**
Max.
2008-2011
Min.
2008-2011
13
7
12
32
4.4%
4.4%
5.4%
4.8%
2.3%
3.5%
5.2%
3.7%
-0.3%
2.4%
4.9%
2.2%
3.3%
7.9%
18.8%
18.8%
-12.3%
4.1%
10.0%
-12.3%
* This is the measure used to construct the "Potential GDP"
** This is the measure used to define the classification as "Low", "Medium" and "High".
Low growth (<4%): St. Kitts and Nevis, Antigua and Barbuda, Grenada, Barbados, Jamaica, Bahamas,
Venezuela, Trinidad and Tobago, St. Vincent and the Grenadines, El Salvador, St. Lucia, Dominica and Mexico
Medium growth (4%-10%): Honduras, Belize,
Haiti, Nicaragua, Guatemala, Costa Rica and
Ecuador
High growth (>10%): Chile, Colombia, Brazil, Guyana, Bolivia, Suriname, Paraguay, Dominican
Republic, Peru, Argentina, Uruguay and Panama
Sources: World Bank’s World Development Indicators – WDI (December 2010), IMF's World Economic Outlook – WEO (April 2011), and Consensus Forecasts (June 2011) –
Latest available forecasts. Potential GDP is calculated computing the annual average real growth rate for the 2002-2007 to 2007 GDP. Weighted averages (2007 Nominal
GDP in USD Billions).
11
LAC’s maturing cyclical recovery
Overheating and endogenous inflationary pressures
Output Gap and Inflation
LAC Countries
30%
CPI Inflation Rate (at June-11)
3 Months Moving Average, YoY
27%
VEN
24%
ARG 2
21%
18%
15%
BOL
12%
9%
JAM
SLV
HND BRB
6%
BRA
CRI
HTI
3%
0%
-8%
ARG
PRY
URY
DOM
-6%
-4%
DMA
-2%
PAN
GUA
ECU MEX
CHL
COL
0%
2%
PER
4%
6%
8%
Output Gap
2011
Notes: The area inside the box represents the range between the lowest and highest midpoints among inflation targeting countries. Sources: National
Statistical Institutes and Central Banks, Haver Analytics.
12
LAC’s maturing cyclical recovery
Double tail spin push: commodity prices & capital inflows
Gross Capital Inflows to LAC-7 Countries
400
350
300
US$ Billions, Annual Flows
Gross Inflows Non-FDI
Gross Inflows FDI
250
200
150
Commodity Prices
Most Relevant for LAC countries
50
Wheat, Copper and Soybean,
Index 01-Jan-05=100
350
0
300
-50
Mar-02
Aug-02
Jan-03
Jun-03
Nov-03
Apr-04
Sep-04
Feb-05
Jul-05
Dec-05
May-06
Oct-06
Mar-07
Aug-07
Jan-08
Jun-08
Nov-08
Apr-09
Sep-09
Feb-10
Jul-10
Dec-10
-100
150
Oil
Copper
Soybean
Wheat
130
110
250
90
200
70
150
Notes: Annualized capital inflows to LAC-7. Sources: IMF’s Balance of Payments Statistics, National Statistical Institutes, and Central
Banks.
Jul-11
Jun-10
May09
Apr-08
30
Mar-07
50
Feb-06
50
Jan-05
100
13
Oil WTI, Current US$
100
Demands on domestic macro-financial policy
Maintain inflation expectations well anchored
Food and Overall CPI Inflation : LAC-7 + URY
YoY Variation, Medians
16%
Food Inflation
14%
Overall CPI Inflation
12%
10%
8%
6%
4%
2%
Jan-11
Jul-10
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
0%
Notes: There is a change in the methodology of calculation for both food and overall PCI index for Chile since January 2009. For the figure on the right, we used the
latest available figure for each country. Weighted averages (2007 Nominal GDP in USD Billions) were used in the case of the regional numbers. Sources: Bloomberg,
Instituto Nacional de Estadísticas de Chile – INE, and Food and Agriculture Organization – FAO (2010) and IMF's World Economic Outlook – WEO (October 2010).
14
Demands on domestic macro-financial policy
Avoid “excessive” currency appreciation
Real Effective Exchange Rate
Weighted Averages, Index Jan-05 = 100
120
115
110
105
100
95
90
85
China
High Income
East Asian Tigers
LAC
May-11
Dec-10
Jul-10
Feb-10
Sep-09
Apr-09
Nov-08
Jun-08
Jan-08
80
ECA
Euro Area
Notes: Weighted averages were calculated using the 2007 nominal GDP in USD Billions. An increase means an appreciation of the REER. Sources: IMF’s International
Financial Statistics – IFS and IMF's World Economic Outlook – WEO (April 2011).
15
Demands on domestic macro-financial policy
Curb systemic risk buildup (financial excesses)
Real Credit Growth in LAC-6 Countries
YoY Growth, %
45%
Total
Housing
Personal
35%
25%
15%
5%
Dec-10
Jul-10
Feb-10
Sep-09
Apr-09
Nov-08
Jun-08
Jan-08
Aug-07
Mar-07
Oct-06
May-06
Dec-05
Jul-05
Feb-05
-5%
Notes: The figure depicts the (PPP-GDP) weighted average of the growth rates of (total, personal and housing) credit to the private sector for the six
largest LAC countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru). Sources: National Statistical Institutes, Central Banks, and Superintendence
of Banking.
16
Adjusting the macro-financial policy response
The need to rebalance the monetary-fiscal policy mix
Monetary Policy Interest Rate Differential
Spread w.r.t FED Funds Rate, In Basis Points
1,600
Brazil
Chile
Colombia
Peru
Mexico
1,400
1,200
1,000
800
Primary Expenditure
% of GDP, LAC-6 Countries
600
20%
400
200
19%
0
18%
Aug-11
Jan-11
Jun-10
Nov-09
Apr-09
Sep-08
Feb-08
Jul-07
-200
17%
16%
Notes: The figures in Panels B is the cyclically-adjusted primary expenditure and primary balance for the major six LAC countries (Argentina,
Brazil, Chile, Colombia, Mexico, and Peru). Sources: Bloomberg, Haver Analytics, National Statistical Institutes, and Central Banks.
17
2010.04
2010.02
2009.04
2009.02
2008.04
2008.02
2007.04
2007.02
2006.04
2006.02
2005.04
2005.02
2004.04
15%
Domestic macro-financial policy
The need to hone the macro prudential policy agenda
 Avoid contributing to amplification – don’t rock the boat



Remove pro-cyclicality in macro and traditional regulatory policy
Allow prudential buffers to be true buffers – i.e., to be used without
penalty during downswings (Goodhart, 2010; Hellwig, 2010)
Remove deeper pro-cyclical factors, such as currency mismatches and
social moral hazard (expectation of bailouts or “Greenspan put”)
 Enhance financial system resiliency to cycle – build a better boat

Add more, systemically-oriented buffers (liquidity and solvency)
 Dampen the cycle – tame the (excess) amplitude of the waves

Incorporate an explicit dampening function into MMP design
 Nip the gestation of adverse financial amplifications in the bud

Induce the internalization of externalities and prevent buildup of
exuberance (Pigovian taxes, approval protocols for innovations)
18
Rising Global Uncertainty and Risks
19
The European Epicenter
Deeper and broader concerns about debt viability
General Goverment Gross Debt (% of GDP)
120%
General Goverment Gross Debt and Fiscal Stance
As a % of GDP and as a % of Potential GDP
100%
80%
60%
Ireland
US
Fra nce
Portugal
UK
Spain
Bra zil
Argentina
40%
20%
Peru
Chile
0%
-12%
Source: IMF WEO (April – 2011)
-10%
-8%
-6%
-4%
-2%
0%
2%
General Goverment Structural Balance (% potential GDP)
4%
20
The European Epicenter
From drama to trauma
CDS (5 years) in Europe
In Basis Points
1800
1600
France
UK
Ireland+Greece+Portugal
Spain
Italy
1400
1200
1000
800
600
400
200
Note: The average CDS is computed for Ireland, Greece and Portugal. Source: Bloomberg
Aug-11
Jul-11
Jun-11
May-11
May-11
Apr-11
Mar-11
Mar-11
Feb-11
Jan-11
Jan-11
Dec-10
Nov-10
Nov-10
Oct-10
Sep-10
Aug-10
Aug-10
0
21
The European Epicenter
Reversal of fortune
Global Sovereign CDS
Dec-2007, in basis points
Global Sovereign CDS
Aug-2011, in basis points
Argentina
Venezuela
Ukrain
Kazakhastan
Tukey
Phillipines
Indonesia
Colombia
Panama
Peru
Vietnam
Brazil
Avg
Russia
Romania
South Africa
Bulgaria
Mexico
Croatia
Thailand
Hungary
Korea
Malaysia
Chile
Poland
Italy
Greece
Slovak Rep
Portugal
Spain
Belgium
France
Germany
Sweden
Greece
Portugal
Venezuela
Argentina
Ukrain
Spain
Italy
Hungary
Vietnam
Croatia
avg
Romania
Bulgaria
Belgium
Tukey
Poland
Kazakhastan
Russia
France
Indonesia
Phillipines
South Africa
Slovak Rep
Peru
Thailand
Brazil
Colombia
Mexico
Korea
Panama
Malaysia
Chile
Germany
Sweden
0
500
1000
Source: Own calculation based on Bloomberg
1500
2000
0
500
1000
1500
2000
22
The U.S. Epicenter
Still well below potential
US Economic Activity
GDP Index base 100 = Iq - 2003
130
125
120
115
110
105
GDP Index
100
2003-2007
Trend
95
Source: National sources
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
90
23
The U.S. Epicenter
A threat of a double dip?
GDP and Unemployment in the US
GDP QpQ SAAR %, Unemployment as a % of
6.0%
12.0%
4.0%
6.0%
-4.0%
4.0%
-6.0%
GDP QoQ SAAR %
Unemployment (rhs)
-8.0%
2.0%
Jun-11
Nov-10
Apr-10
Sep-09
Feb-09
Jul-08
Dec-07
May-07
0.0%
Oct-06
-10.0%
Mar-06
Industrial Production and ISM Index
Industrial Production (YoY %)
70
10.0%
60
5.0%
50
0.0%
40
-5.0%
30
-10.0%
20
ISM Index
-15.0%
10
Industrial Production (% YoY, rhs)
Source: National sources.
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
Jan-09
May-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
-20.0%
Jan-06
0
24
Industrial Production (YoY)
-2.0%
ISM Index
GDP QoQ SAAR
8.0%
0.0%
Unemployment Rate
10.0%
2.0%
The U.S. Epicenter
Narrowing room for policy maneuvering
The FED Balance Sheet - Assets Side
Factors Affecting Reserve Balances, US$ Billion
3,000
Other
Central Bank Liquidity Swaps
2,500
New Program Portfolio
2,000
Loans and Discounts
Including Float
Term Auction Facility (TAF)
1,500
FED Funds Rate and Taylor Rule Estimation
Treasury Securities
8.0%
1,000
6.0%
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
2.0%
Sep-07
0
May-07
4.0%
Jan-07
500
0.0%
-2.0%
Spread
-4.0%
Taylor Rule Rate Estimation (Bloomberg Model)
FED Fund Rate
Source: National sources.
25
Jul-11
Apr-10
Jan-09
Oct-07
Jul-06
Apr-05
Jan-04
Oct-02
Jul-01
Apr-00
Jan-99
Oct-97
Jul-96
Apr-95
Jan-94
Oct-92
Jul-91
-6.0%
The U.S. Epicenter
The downgrade and the swing in market sentiment
Market Trends and Volatility
VIX Index and S&P 500
90
1800
VIX Index
80
S&P 500 (rhs)
70
1400
QEI
60
50
40
30
1200
Lehman
Briothers
US
Flash downgrade
Crash/
PIGS
Japan
20
10
1000
800
600
400
Jackson
Hole
(QEII)
200
0
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
0
1600
Source: Bloomberg
26
The U.S. Epicenter
The downgrade and global financial coupling
Stock Markets: 2011
In USD, Index base 100 = Jan - 2011
120
110
100
Emerging Market Asset Returns and Common Factors
Average R-Squared from Country Regressions
100%
Early Period (2000-2005)
Late Period (Jan-05 to Jul-08)
Crisis (Aug-08 to Apr-09)
90%
Jul-11
Jul-11
Jul-11
Jun-11
Jun-11
May-11
May-11
Apr-11
Apr-11
Mar-11
Mar-11
80%
Feb-11
Jan-11
Jan-11
70
Feb-11
80
Jan-11
Brazil
S&P 500
Japan
UK
Germany
France
Percent
90
70%
60%
50%
40%
30%
20%
10%
0%
Equity
Source: Bloomberg
Foreign Exchange
CDS Spreads
27
The U.S. Epicenter
Downgraded but still the safe haven
Gold and US T10
2011
1800
4.0%
Gold
1700
US T10 (rhs)
3.5%
1600
1500
3.0%
Currencies: 2011
Index base 100 = 1-Jan-2011
115
1400
Japan
UK
US-EUR
Brazil
2.5%
Aug-11
Jul-11
Jul-11
Jun-11
Jun-11
May-11
May-11
Apr-11
Apr-11
Mar-11
Mar-11
Mar-11
Feb-11
2.0%
Feb-11
1200
Jan-11
110
Jan-11
1300
105
100
95
Source: Bloomberg
Aug-11
Jul-11
Jun-11
May-11
Apr-11
Mar-11
Jan-11
Dec-10
90
28
The China Epicenter
Danger of an abrupt adjustment?
China: Inflation and Industrial Production
YoY %
25%
Inflation
Industrial
Production
20%
15%
180
China Total Imports
CRB Index (rhs)
160
0%
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
Jan-06
-5%
Total Imports, US$ Billions
5%
700
600
140
500
120
100
400
80
300
60
200
40
100
20
0
Source: National sources.
Jun-11
Jan-11
Aug-10
Mar-10
Oct-09
May-09
Dec-08
Jul-08
Feb-08
Sep-07
Apr-07
Nov-06
Jun-06
Jan-06
0
29
CRB Index
10%
China Total Imports and CRB Index
Imports in U$S Billions
Whither LAC?
30
Benign scenario: real decoupling continues
Can LAC turn cyclical recovery into higher trend growth?
 Successful management of the cycle is essential to break free
from the historical boom-bust pattern
 LAC bumps against structural speed limits at comparatively low
growth rates

Productive capacity in LAC lacks the efficiency and flexibility to
accommodate robust long-run growth rates
 Could the region turn natural resources into a blessing?



Saving – for stabilization and asset building
Diversification – avoiding the “enclave” syndrome
Institutions – avoiding corrosive effects of rent-seeking
31
LAC has experienced 100 years of growth solitude
One Hundred Years of Solitude
GDP Per Capita Relative to the US, Weighted Averages
60%
Interwar Period
Gold Standard
Period
Washington
Dissensus
Lost
Decade
Import Substitution
Washington
Consensus
50%
40%
30%
LAC
20%
10%
East Asian Tigers / US
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
1945
1940
1935
1930
1925
1920
1915
1910
1905
1900
0%
Note: The
Notes:
wasgroup
. Source:
of East
IFM’s
Asian
IFS tigers includes Hong Kong (China), Indonesia, Malaysia, Republic of Korea, Singapore, Thailand, and Taiwan (China).
Maddison (2007-2009) was used from 1900 to 2006. We used the Real Per Capita GDP growth from WDI to calculate the levels from 2006 to 2010.
Source: LCRCE Staff calculations based on Maddison (2007, 2009) and WDI
32
Bad scenario: global downward re-coupling
How much can LAC’s new “immune system” resist?
 Robust monetary policy frameworks in LAC, mostly

Shock absorption via e-rate flexibility/monetary policy independence
 How good are LAC’s fiscal buffers?

Comfortable public debt situation but insufficient fiscal flexibility
 How good are LAC’s financial system buffers?


Strong capital and liquidity positions
Have systemic risks been brewing in the past year or so?
 How good are LAC’s social safety nets?


Ability to scale up social assistance programs vary widely in the region
Social insurance frameworks are the weak link
33
Thank you
34