Latin America and the External Crisis: An Overview

The international crisis of the past three years arrived when most Latin American countries were successfully adapting their policies to achieve and maintain macroeconomic stability, create a more open trade regime with fewer distortions, develop a more robust financial system along with competitive market structures, and restructure the public sector. The onset of international crisis put stress on economic policies in the regions: it resulted, in particular, in a sharp deterioration in the terms of trade, a substantial increase in borrowing spreads and a sudden reduction of capital flows. That, in turn, put pressure on current accounts and exchange rate regimes, and forced the introduction of restrictive fiscal and monetary policies.

By contrast with previous crises, this time most Latin American countries avoided policy action to seal off their economies and to introduce expansionary fiscal and monetary policies in an attempt to stabilize output. The typical response has been to introduce restrictive macroeconomic policies to reduce current account deficits and to facilitate the real depreciation that must accompany a drop in the terms of trade. A number of countries have adopted more flexible exchange rate regimes, meaning that they are targeting the rate of inflation in adopting an appropriate monetary anchor. Fiscal discipline and Central Bank independence provide the institutional underpinnings for the inflation target strategy.