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POLICY RESPONSES TO SUDDEN STOPS Some comments from Argentina Hernán Lacunza Head of Research

POLICY RESPONSES TO SUDDEN STOPS Some comments from Argentina Hernán Lacunza Head of Research Central Bank of Argentina. Inter-American Development Bank October 18, 2007. Plan. Transmission mechanisms of sudden stops Responses vs. prudential policies

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POLICY RESPONSES TO SUDDEN STOPS Some comments from Argentina Hernán Lacunza Head of Research

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  1. POLICY RESPONSES TO SUDDEN STOPS Some comments from Argentina Hernán Lacunza Head of Research Central Bank of Argentina Inter-American Development Bank October 18, 2007

  2. Plan • Transmission mechanisms of sudden stops • Responses vs. prudential policies • Argentina sudden stops (1995 & 1998-2001) • Argentina current policy • Concluding remarks

  3. Sudden stops’ transmission mechanisms • Transmission mechanisms (Calvo, Izquierdo and Mejía, 2004) • Trade Openness • Financial dollarization • An example: Argentina and Chile (Calvo and Talvi, 2005)

  4. Trade openness: “timing and CA composition matters”

  5. Fear of floating exceeds dollarization Asia?

  6. Policy responses to sudden stops? • Montiel (2003): “ a lesson we have not learnt” • Reasons for contractionary fiscal policies • Resources for financial sector insolvency • Current account adjustment • But • Procyclical effects (Ortiz, Ottonello, Sturzenegger, Talvi, 2007): sudden stop only gets worse

  7. Argentina: the role of fiscal adjustment • A much tighter adjustment after the Russia-Brazil sudden stop

  8. Argentina: costly adjustment to sudden stops • Episode I: Tequila • “Transitory” vs “permanent” shock: • Higher c/a reversal • Higher drop in absorption • Lower export response • Higher output drop • Episode II: Russia & Brazil

  9. Argentina 2001: conditions for a “perfect storm”

  10. Argentina 2001: conditions for a “perfect storm”

  11. Healing wounds or preventing accidents? • Response? Few to do once the sudden stop happens • Countercyclical policies are not available during sudden stops: fiscal tightening may be worse • Prudential policies: higher ability to face sudden stops

  12. Corridor: Argentina – Australia - Brazil

  13. Argentina: no absortion mechanisms

  14. Negative correlation between volatility and growth

  15. Prudential policies • Contingent credit lines: not available in sudden stops • De-dollarization: not so easy Argentina 2007: • Capital controls: effective to alter inflow composition • Reserves accumulation: self-insurance • Financial & fiscal strengthening • Exchange rate regime: flexibility to cope with shocks

  16. Strenghtening of financial system

  17. Reserve accumulation

  18. Fiscal solvency

  19. External solvency

  20. What role for the foreign exchange regime? • Flexibility to deal with crises (Arg vs. Chile) • Asymmetric role in triggering crises • Macroeconomic consistency • Avoiding overvaluations is associated to growth (Rajan, 2007); undervalued real exchange rate linked to growth (Rodrik, 2007; Levy-Yeyati, 2007; Eichengreen, 2007) • Real exchange rate policie foster domestic savings, reduce required adjustment in face of sudden stops

  21. Real exchange rate misalignments • Misalignment when a sudden stops hits is far from neutral

  22. Concluding remarks • Sequence of international insertion matters • Worldbank 1997, about SS: initial condition matters: real exchange rate out of line, large government debt, fiscal adjustment perceived as infeasible • IMF 2007: heavy capital inflows may pose significant challenges to macroeconomic stability (fiscal policies); countries with more volatility… faced stronger real value of the currency during the period of capital inflows • Few to do once sudden stops happen; prudential policies and macroeconomic consistency

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