1. A BROAD VIEW OF MACROECONOMIC STABILITY JOSÉ ANTONIO OCAMPO UNDER-SECRETARY-GENERAL UNITED NATIONS

2. A BROAD VIEW OF MACROECONOMIC STABILITY  Not only inflation and fiscal balance, but also: Economic activity and employment External sector balance Balance sheets of financial and non-financial agents  Counter-cyclical macroeconomic policies are key  So, need to go beyond “inflation targeting”: Output and real exchange targeting, additional instruments…  …and supportive international financial institutions

3. MACROECONOMIC (IN)STABILITY (1)  Markets are inherently unstable  This is partly a question of price and wage “rigidities”…  …but particularly of the functioning of financial markets (risk/information asymmetries generate inherently incomplete markets): Alternation of high “risk appetite” and “flight to quality” Rationing of credit, particularly during downturns Contagion

4. MACROECONOMIC (IN)STABILITY (2)  For developing countries: strong cyclical swings and pro-cyclical macro policies  This reflects inherent asymmetries of the international system: Different capacity to issue debts in domestic currencies Degrees of financial market development Size of markets  Features of financial cycles: Variations in availability, price and maturities Short-term but, particularly, medium-term fluctuations  Self-insurance is possible but costly

5. UNSTABLE ACCESS TO EXTERNAL FINANCING…

6. … AND VOLATILE SPREADS

7. MACRO POLICIES: THE EXCHANGE RATE REGIME (1)  With trade and capital account liberalization, loss of policy instruments to manage shocks.  Thus, greater reliance on exchange rate…  … but exchange rate fluctuations have a counter-cyclical trade but pro-cyclical wealth effects…  … and are subject to conflicting demands: Demand for stability (price stability, stable trade incentives, avoiding pro-cyclical wealth effects) Demand for flexibility (room of maneuver to manage shocks)

8. MACRO POLICIES: THE EXCHANGE RATE REGIME (2)  An adequate management of the exchange rate regime must recognize the multiple objectives of macroeconomic policy…  …which implies that some degree of exchange- rate targeting is essential…  …and is the normal policy option

9. THE TRADITIONAL VIEW: THE IMPOSSIBLE TRINITY

10. PROBLEMS WITH THE TRADITIONAL VIEW  “Credibility” of pegs (even hard pegs) vary and are pro-cyclical, thus making this instrument more procyclical in developing countries.  “Monetary autonomy” under flexible exchange rates is also limited: Pro-cyclical wealth effects. Supply effects of exchange rates on domestic prices Endogeneity of capital flows.  So, the room for monetary autonomy may be greater under “intermediate regimes”, but: Effective capital account regulations are key Costs of counter-cyclical reserve management Credibility issues

11. MACRO POLICIES: FISCAL POLICY (1)  Fiscal policy can always play a counter-cyclical role.  But markets push it in a different direction: Taxes, financing and debt service are procyclical Contingency financing is also procyclical.  And there are political-economy arguments that push in the same direction: Compensating pro-cyclical booms of private spending is politically difficult If there was austerity during the preceding crisis, it is also difficult to justify it during booms  Procyclical fiscal policy has adverse effects on the efficiency of public sector spending and on growth.

12. PROCYCLICAL POLICIES REGION CYCLICALITY OF FISCAL POLICY (INDEX) OECD- 0.11 (countercyclical) High-to-Middle Income Developing Countries 0.28 (highly procyclical) Middle-to-Low Income Developing Countries 0.17 (moderately procyclical) Low-Income Countries 0.28 (highly procyclical) Africa0.30 (highly procyclical) Latin America0.25 (highly procyclical) Asia 0.16 (moderately procyclical)

13. Pro-cyclical macroeconomic policy in developing countries has been harmful for growth  Pro-cyclical fiscal policies negatively affect long term-growth  Unstable public spending have negatively affected investments in infrastructure and human development

14. MACRO POLICIES: FISCAL POLICY (2)  Policy options: Define a structural stance of the public sector. Actively use stabilization funds Automatic stabilizers (spending or taxes) may be preferable to discrete decisions.

15. CAPITAL MANAGEMENT: CAPITAL ACCOUNT REGULATIONS (1)  Second best intervention: segment what is already segmented.  Traditional regulations: segment according to residents and non-residents, and existing economic links.  For countries already integrated in to world capital markets: Temporary administrative controls (Malaysia, 1994 and 1998) Price-based regulations (Unremunerated Reserve Requirements, URR).

16. CAPITAL MANAGEMENT: CAPITAL ACCOUNT REGULATIONS (2)  Lessons from experience: Both controls on outflows and inflows can work, but quantitative restrictions may be easy to administer Dynamic adjustment is necessary to close loopholes, and in any case regulations are “leaky” Traditional controls work better if the objective is to reduce procyclical flows. Quantitative controls have stronger effects… … but price-based regulations are also effective Capital account regulations are a complement, not a substitute of adequate macro policy

17. THE EFFECT OF CAPITAL-ACCOUNT REGULATIONS

18. CAPITAL MANAGEMENT: MACRO-PRUDENTIAL REGULATIONS  Risks that financial sector faces have a large macroeconomic component: Financial markets are pro-cyclical Traditional regulation have a pro-cyclical bias Price-sensitive risk management is also pro- cyclical.  Essential tools: Forward-looking provisioning (rather than capital) Discretionary prudential provisioning, based on growth of credit (general, by sector, by agent) Regulation of maturity and, particularly, currency mismatches. Valuation of collaterals.

19. CAPITAL MANAGEMENT: PUBLIC SECTOR LIABILITY MANAGMENT  Maturity of domestic liabilities of the public sector matter.  Avoid dollar/euroization of domestic liabilities  Counter-cyclical swings between domestic and external financing.

20. INTERNATIONAL COOPERATION  The room of maneuver for counter-cyclical policies should be at the center  Surveillance to avoid building up unsustainable dynamics.  Smoothing financing at the source  IFIs as “market makers” for counter-cyclical instruments  Counter-cyclical financing.