Journal Issue

Bretton Woods Committee: Why is Latin America still prone to crises?

International Monetary Fund. External Relations Dept.
Published Date:
January 2003
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Latin America still crisis prone?

Enrique Iglesias, President, Inter-American Development Bank, set the stage for the conference with a review of the economic, social, and political turmoil in Latin America over the past year and the less-often-highlighted bright spots in the region. Many countries had been experiencing weak growth or recession, rising unemployment, increasing poverty, a collapse in capital inflows, and high interest rates and levels of debt—which left little room to pursue countercyclical policies. Nonetheless, others—including Chile, Mexico, and Peru—had been recording moderate growth and were relatively untouched by the problems in the region. Foreign direct investment had also held up relatively well despite financial strains in the region.

Roots of financial crises

Why have the ghosts of crisis and volatility come back to haunt the region? And what policies are needed to put the region back on a more positive course? Harvard University’s Ricardo Hausmann stressed that the key to understanding why Latin America is prone to repeated crises relates to sudden drops in capital inflows to the region and the inability of these and other emerging market countries to borrow internationally in their own currency—a condition he has dubbed “original sin.”

With accumulated debt denominated in foreign exchange, foreign-currency-denominated liabilities far outweigh assets, so that countries’ balance sheets suffer from a serious currency mismatch. Exchange rate depreciations then have seriously negative consequences. To alleviate these problems, Hausmann proposed creating a synthetic basket currency based on a set of emerging market currencies. The international financial institutions, he suggested, could issue debt in this synthetic currency and offer loans denominated in the local currencies to each of the emerging market countries in the basket. The major industrial nations could also issue debt denominated in the basket currency and then swap out of it with each country whose currency is included.

Michael Mussa, Senior Fellow at the Institute for International Economics, agreed that the inability of developing countries to issue debt in their own currency was important, but he emphasized that other factors also played crucial roles. First, many Latin American countries lacked fiscal discipline and had therefore accumulated high levels of public debt that left them vulnerable to domestic and external shocks. Second, in emerging market countries with long histories of financial problems, easing monetary and fiscal policies tends to be ineffective in alleviating financial strains. A tightening of policy is needed, but it may have a negative impact on economic activity in the short term. Third, international trade for most Latin American countries is limited (particularly relative to Asian countries), and exchange rate depreciation does little to boost the economy via a pickup in exports. Mussa stressed that strong domestic policies are a prerequisite for Latin America to be less vulnerable to crisis.

A more resilient Latin America also requires, in the view of the U.S. administration, a greater emphasis on policies that promote growth. Randal Quarles, Assistant Secretary for International Affairs at the U.S. Treasury, discussed recent U.S. initiatives to promote higher growth and foster increased economic and financial stability in emerging market countries, particularly in Latin America. He emphasized U.S. efforts to further liberalize trade and strengthen financial linkages with Latin America.

Future of democratic institutions

Dissatisfaction with the results of democracy has been on the rise in Latin America, with political turmoil erupting in a number of countries. But Mark Falcoff, a Resident Scholar at the American Enterprise Institute, remained optimistic about the future of the region’s democratic institutions. He cited a rise in the number of civil society organizations—in particular, nongovernmental organizations actively promoting human rights and environmental concerns—as a promising sign and noted the growth of a vibrant free press and access to electronic media.

The full text of the remarks of the symposium speakers is available on the website of the Bretton Woods Committee (

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