During the last few years, most Latin American countries have been confronted with increasingly serious balance of payments and economic difficulties. For 1982, practically every country in the region—whether an oil exporter or not—will show a significant current account deficit, accompanied by higher inflation rates and economic sluggishness that will be reflected in very low growth rates or—frequently—absolute declines in economic activity. As a matter of fact, 1981 and 1982 could be best described as the worst economic years the region has experienced in decades.
Numerous attempts have been made to identify and to explain the causes of such a poor economic performance. These have generally been based on evaluations of individual country cases, and the explanations have centered around the misuse of important domestic economic policy instruments: excessive levels of public expenditures, as have allegedly been seen in oil exporters like Mexico and Venezuela, or “unrealistic” exchange rate policies, as have allegedly been seen in Argentina, Chile, and Uruguay. In a few countries, particularly in Brazil, blame has also been placed on some specific external factor, such as oil price increases, or on the external debt burden.
Confronted with these situations, many Latin American countries have implemented, in the recent past, severe external adjustment policies centered basically around massive exchange rate depreciations; included among the adjusting countries are Ecuador and Paraguay, which depreciated their currencies after years of absolute stability.
It is worth mentioning that the majority of adjusting countries have achieved some degree of improvement in the current account (basically through recession-induced reductions in imports) immediately after the devaluations, but the overall balance of payments has, in most countries, tended to deteriorate shortly after, forcing much larger devaluations than were originally envisaged. The cycle of devaluation, inflation, recession, capital outflows, wage increases, fiscal deficit, and further devaluations is well under way in many of the adjusting countries, and it is very difficult to envisage what the end results of these competitive adjustment policies will be. To a certain extent, “beggar my neighbor” policies seem to be in evidence.
In analyzing these facts, the researcher is immediately struck by the strange “coincidence” that most countries in the region have simultaneously applied apparently “erroneous” economic policies (even though their “errors” originated in diverse economic policies); the possibility that one or more external disturbances have simultaneously affected most of the region appears, in these circumstances, to be an additional explanatory variable worth exploring. In fact, some individual countries (i.e., Brazil and Chile) and some international organizations have been claiming that at least part of these difficulties have originated in external factors (world recession, high nominal and real interest rates, low primary product prices), but little systematic work has been done on this subject. In particular, there has been little research on the differential effects of these external economic disturbances on the different sectors of the economy and on how alternative domestic economic policies may strengthen or weaken the internal effects of these external disturbances.
A final answer to these questions would require the complete specification of the type of external economic disturbance to be transmitted and the study of the transmission mechanism of such disturbances, the specification of the economic structures of the countries subject to such disturbances, etc.—tasks that lie completely outside the scope of the present paper. It is possible, however, if one uses some simplifying assumptions, to obtain some general answers to questions about the ways in which economic cycles are transmitted, the differential effects of such disturbances, and the possibilities of successfully applying countercyclical domestic measures.
In particular, it is the purpose of this paper to study the effects of a stereotyped cycle—to be described in the section entitled “The Model”—on a small (price taker), semi-open economy under alternative domestic policy scenarios.
APPENDIX: EXPLANATORY EXAMPLE
Ricardo H. Arriazu is Economic and Financial Consultant to the Banco Comercial del Norte in Buenos Aires. He was formerly an Advisor to the Presidency of the Central Bank of Argentina and an Alternative Executive Director of the Fund. He has written numerous papers on international finance, capital and financial markets, monetary theory, and the problems of small, semi-open economies.
Many developing countries have systematically announced that their currencies were floating freely in moments of crisis, but have generally returned to pegging to their major intervention currencies after very short intervals.
This assumption could be justified by differences between the speeds of adjustment, between consumption and production, to changes in relative prices, which imply that producers anticipate cyclical changes in relative prices while consumers do not.
An even stranger development could take place in beef exporting countries, where the improvement in the terms of trade—if thought to be permanent—might induce a retention cycle that would involve a short-run reduction in the volume of exports.
In moments of exchange speculation, leads and lags in payment for exports and imports tend to reinforce or modify the normal behavior of these variables. Since this model has assumed total consumption during the period, however, commodity speculation is excluded.
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