Developing countries' anti-cyclical policies in a globalized world

Introduction The volatility and contagion characteristic of international financial markets, which have dominated emerging economies during the 1990s, have long historical roots.1/ Indeed, from the mid-1970s to the end of the 1980s, Latin America and other regions in the developing world experienced a long boom-bust cycle, the most severe of its kind since that of the 1920s and 1930s. The shortening but also the intensity of boom-bust cycles have been distinctive features of the recent decade. The latter is reflected, in the words of the Chairman of the Federal Reserve Board, in the fact that the 'size of the breakdowns and required official finance to counter them is of a different order of magnitude than in the past'.2/ Viewed from the perspective of developing countries, the essential feature of instability is the succession of periods of intense capital inflows, in which financial risks significantly increase, facilitated and sometimes enhanced by pro-cyclical domestic macroeconomic policies, and the latter phase of adjustment, in which not only are these risks are exposed but also the pro-cyclical character of the measures adopted to 'restore confidence' amplify the flow (economic activity) and stock (portfolio) effects of adjustment processes. An essential part of the solutions to these problems lies in strengthening the institutional framework to prevent and manage financial crises at the global level.3/ This paper looks, however, at the role of developing countries' domestic policies in managing the pro-cyclical effects of externally generated boom-bust cycles. It draws from an extensive recent literature on the subject 4/ and from the experience of Latin America in the 1990s.5/ It is divided in seven sections. The first two look at the international asymmetries that lie behind and the specific macroeconomics of boom-bust cycles in the developing world. The following sections look at the exchange rate regime, liability policies, prudential regulation and supervision, and fiscal stabilization. The final section draws some conclusions. 1 See, for example, in relation to Latin America, Bacha and Díaz-Alejandro (1982). 2 Greenspan (1998). 3 There is an extensive literature on these issues. See, for example, Eatwell and Taylor (2000), Eichengreen (1999) and Ocampo (1999a, 1999b). 4 Among the many recent contributions to the analysis of this issue, see CEPAL/ECLAC (1998a, Part Three; 2000a, Ch. 8), Ffrench-Davis (1999), Furman and Stiglitz (1998), Helleiner (1997), Ocampo (1999b, ch. 5) and World Bank (1998), chapter 3. 5 Latin America's experience is regularly analyzed in ECLAC's economic surveys. See, for example, CEPAL/ECLAC (1999) on the effects of the Asian crisis.