commodity prices and exchange rate policies during the...
TRANSCRIPT
1
MIGUEL A. KIGUEL – JAVIER OKSENIUK
September 2009
2010 Latin America and the Caribbean Regional Flagship
Commodity Prices and Exchange Rate Policies During the Recent Boom and Bust
in Latin America and the Caribbean
2
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
3
Commodity swings as a challenge for monetary and exchange rate policies in developing countries
Motivation and Purpose of the Paper
Terms of Trade Shocks in Previous Episodesas % of GDP
1974 1979-81 2004-07Argentina -0.9 -1 5.8%Brasil -2.6 -3 5.0%Chile -12.4 -5 49.9%Colombia 0.9 -3.1 7.8%Costa Rica -5.1 -4.3 -11.9%Indonesia 17 11.9 naNigeria 23.1 14.3 na
Source: Cooper (1993) and own calculations
4
Commodity swings as a challenge for monetary and exchange rate policies in developing countries
Motivation and Purpose of the Paper
Terms of Trade Shocks and Real Exchange Rate Movements
1974-78 2004-07 1974 2004-07Indonesia -33% n.a. 17% n.a.Nigeria -29% n.a. 23% n.a.Venezuela n.a. -47.8% 52%Chile n.a. -37.7% 50%Bolivia n.a. -18.3% 22%Panama n.a. -9% -14%Honduras n.a. -19% -24%Nicaragua n.a. -15% -27%
Source: Cooper (1993), Alan H. Gelb 1988, and own calculations
Real Exchange Rate Variation Terms of Trade Shock
5
Motivation and Purpose of the Paper
Try to asses the effectiveness of different exchange rate regimes and of alternative policy measures (such as fiscal policy and capital controls) to deal with terms of trade shocks:
Degree of appreciation of the currency for those countries that benefited from a positive terms of trade shock
The impact of the increase in food prices (agflation) and of overall inflation during commodity booms on the economy
Effectiveness of different exchange rate systems to buffer the negative impact of the commodity booms as well as to cope with a possible reversal of a commodity boom
6
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
7
Analytical Framework
We consider a simple analytical framework based in the Salter-Swan model with 3 goods Non-traded good (N)
Tradeable good (T)
Commodity (C)
Nominal income is defined as:
ccttnnn XPXPXPY ++=
And prices as:
*. tt PEP = *. cc PEP =
8
Analytical Framework The consumption of the non-tradeable (Cn) and of the tradeable (Ct ) good depend on relative prices and on the level of aggregate demand:
= α.AD , C
t
nnn P
PC
= AD
PPC
t
ntt . α)-(1 , C
We assume that AD, aggregate demand, is a function of nominal disposable income (Yn) and the fiscal surplus, where Yn is defined as:
ccnnttn YPYPYPY ... ++=
The Current Account (in foreign currency) is:
ccttt XPCYP .)(CA ** += −
9
Analytical FrameworkEquilibrium in the non-tradeable good and in the current
account of the balance of payments
Real Exchange
Rate
Aggregate Demand
AD0 AD1
NN
XX
R0
R1
An increase in Commodity Prices (Pc) generates a real appreciation
10
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
11
Methodology
Our methodology to define the exchange rate regime is based on Levy-Yeyati and Sturzenegger (2005).
They divide the countries in 3 groups, based on 3 variables:
Exhange Rate Volatility
Volatility of Exchange Rate Changes
Volatility of International Reserves
12
MethodologyWe classify the countries in 3 groups:
Previous Exchange Rate Regime Classification and Nominal Excahge Rate (Jan04=100)
Dic-04 Dic-05 Dic-06 Dic-07 Dic-08 Jul-09Hard PegEcuador 100.0 100.0 100.0 100.0 99.6 99.6
El Salvador 100.0 100.0 100.0 100.0 100.0 100.0Panama 100.0 100.0 100.0 100.0 100.0 100.0
IntermediateArgentina 101.5 103.6 104.5 107.7 118.0 130.8
Bolivia 102.1 101.2 101.1 95.9 88.9 88.7Costa Rica 108.7 117.7 122.9 117.7 132.4 138.8Honduras 104.6 106.1 106.1 106.1 106.1 106.1Nicaragua 104.4 106.1 115.4 121.1 127.3 127.9Venezuela 120.0 134.4 134.4 134.4 134.4 134.4Floaters
Brasil 90.5 79.6 72.8 60.6 78.8 63.5Chile 95.1 88.0 91.1 85.2 108.8 92.5
Colombia 85.8 83.5 81.7 73.7 82.0 74.3Dominican Rep 57.5 68.0 66.2 66.6 70.9 72.6
Guatemala 95.3 93.4 93.9 94.0 95.4 100.3Jamaica 101.4 106.4 110.7 117.4 131.5 146.3Mexico 100.6 96.1 97.6 98.5 123.4 119.1
Paraguay 98.5 97.9 83.0 76.4 78.3 80.1Peru 93.6 97.7 91.3 85.7 89.5 85.3
Uruguay 91.1 83.3 83.9 74.1 83.8 80.3
13
MethodologyNER volatility was naturally higher in flexible regimes and the
intermediates had a higher level of intervention than the floaters through most of the period
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
Ene-
05
May
-05
Sep-
05
Ene-
06
May
-06
Sep-
06
Ene-
07
May
-07
Sep-
07
Ene-
08
May
-08
Sep-
08
Ene-
09
May
-09
Hard PegIntermFloaters
NER Volatility
0.0%
0.1%
0.2%
0.3%
0.4%
0.5%
0.6%
0.7%
0.8%
0.9%
Ene-
05
May
-05
Sep-
05
Ene-
06
May
-06
Sep-
06
Ene-
07
May
-07
Sep-
07
Ene-
08
May
-08
Sep-
08
Ene-
09
May
-09
Hard PegIntermFloaters
IR Variation in absolute value
14
Methodology
We summarize the evolution of the three variables to classify exchange rate regimes. We use a slightly different methodology to LY-S (2005). We compute a simple and ad hoc formula that assigns a value for each of the three variables in order to consolidate these trends into a single one.
Our formula indicates that in periods when countries were facing a stress scenario like an adverse shock in the terms of trade, floaters were maintained their the de facto regime that was in place prior to that date. It thus seems that floaters were really floaters, while intermediates turned, on average, into a more fixed scheme.
15
MethodologyNo group of countries has crossed over, on average, the others,
indicating some kind of regularity of the regimes.
-2.00%
-1.50%
-1.00%
-0.50%
0.00%
0.50%
1.00%
Ene-
05
May
-05
Sep-
05
Ene-
06
May
-06
Sep-
06
Ene-
07
May
-07
Sep-
07
Ene-
08
May
-08
Sep-
08
Ene-
09
Hard PegIntermFloaters
Regime Formula A - with absolute values
16
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
17
Stylized facts of the last cycle Winners and Loser in the last Commodity boom
Terms of Trade Shockas % of GDP, cumulative shock between 2003 and 2007
Venezuela 52.3%Chile 49.9%Bolivia 22.2%Peru 17.1%Ecuador 14.5%Colombia 7.8%Argentina 5.8%Brasil 5.0%Mexico 3.7%Paraguay -6.5%Uruguay -9.6%Dominican Republic -9.9%El Salvador -10.5%Costa Rica -11.9%Guatemala -13.6%Panama -14.4%Honduras -24.1%Nicaragua -26.6%
18
Stylized facts of the last cycle Regardless of the difference in the evolution of the terms of
trade, there were some common features regarding macroeconomic variables among countries, that to a large
extent can be attributed to a favorable external environment Real GDP Growth
Annual variation
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
6.5%
Hard Peg Intermediate Floaters
2004 2005 2006 2007
Current Accountas % of GDP
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
Hard Peg Intermediate Floaters
2004 2005 2006 2007
Sovereign Interest RatesEMBI Index, in basis points
0
100
200
300
400
500
600
700
800
900
1000
Hard Peg Intermediate Floaters
2004 20052006 2007
International Reservesas % of GDP
5%
7%
9%
11%
13%
15%
17%
19%
21%
23%
Hard Peg Intermediate Floaters
2004 2005 2006 2007
Foreign Direct Investmentas % of GDP
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
Hard Peg Intermediate Floaters
2004 2005 2006 2007
19
Stylized facts of the last cycle The three groups of countries experienced a real appreciation of the currency, suggesting that there were common features
pushing towards stronger currencies
20
Stylized facts of the last cycle Real appreciation mainly took place through nominal
appreciations in the floaters and trough inflation in hard peg and intermediates
21
Stylized facts of the last cycle Floaters used monetary policy (high interest rates) to target low rates of inflation while intermediates and hard pegs use
NER as the nominal anchor
Real Interest RateIn percentage points
-6%
-4%
-2%
0%
2%
4%
6%Q
1 20
04
Q3
2004
Q1
2005
Q3
2005
Q1
2006
Q3
2006
Q1
2007
Q3
2007
Q1
2008
Q3
2008
Floaters
Intermediate
Hard Peg
22
Stylized facts of the last cycle
Factors that could have contributed to the real appreciation in this period:
Terms of trade gains
Capital flows
Expansions in domestic bank credit
Fiscal policy
Higher real interest rates
Improvements in macro-fundamentals
23
Stylized facts of the last cycle There is evidence that the extent of the real appreciation was
related to the size of the terms of trade gains
Terms of Trade Gains vs. Real Exchange Rate
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
-15%
-10% -5% 0% 5% 10%
15%
20%
Terms of Trade Gains as % of GDP
Rea
l Exc
hang
e R
ate
2003
=1
Hard Peg
Intermediate
Floaters
Terms of Trade Gains vs. Real Exchange Rate(cumulative gains and REER variation, 2004-07 )
Uru
Per
Par
Mex
Gtm Dr
Col
Chi
Bra
Ven
Nic
Hon
Cri
Bol
Arg
Pan
Slv
Ecu
-65%
-55%
-45%
-35%
-25%
-15%
-5%
-40%
-30%
-20%
-10% 0% 10%
20%
30%
40%
50%
60%
Terms of Trade Gains as % of GDP
Rea
l Exc
hang
e R
ate
24
Stylized facts of the last cycle The role of capital inflows
Capital Account Variation As % of GDP
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
Hard Peg Intermediate Floaters
2004-07 vs. 20032S.08-1Q.09 vs. 2007
Capital flows increased besides the exchange rate regime and whether the countries were winners or losers in terms of the commodity boom
The reversal was also “commodity blind”
25
Stylized facts of the last cycle Were capital flows pro-cyclical (correlated with the commodity
cycle) during the boom?
Terms of Trade Shock vs. Cap. Account Variation2007 vs. 2003, as % of GDP
-40%-30%-20%
-10%0%
10%20%30%
40%50%60%
Arg
enti
na
Bol
ivia
Cost
aR
ica
Hon
dura
s
Nic
arag
ua
Vene
zuel
a
ToT Shock Capital Account Variation
Terms of Trade Shock vs. Cap. Account Variationas % of GDP
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
Bra
sil
Chile
Colo
mbi
a
Dom
inic
anR
ep
Gua
tem
ala
Mex
ico
Para
guay
Peru
Uru
guay
ToT Shock Capital Account Variation
26
Stylized facts of the last cycle And during the bust?
Terms of Trade Shock vs. Cap. Account Variation2S.08/1Q09 vs. 2007, as % of GDP
-15%
-10%
-5%
0%
5%
10%
15%
Arg
enti
na
Bol
ivia
Nic
arag
ua
Vene
zuel
a
Bra
sil
Chile
Gua
tem
ala
Mex
ico
Peru
ToT Shock Capital Account Variation
27
Stylized facts of the last cycle The evidence is mixed: multiple factors were playing in
different senses
Capital Flows vs. REER(cumulative 2004-07 gains and REER variation)
-60%
-50%
-40%
-30%
-20%
-10%
0%
-20%
-10% 0% 10%
20%
30%
40%
Capital Account variation vs. 2003 as % of GDP
Rea
l Exc
hang
e R
ate
2003
=1
Capital Account vs. Real Exchange Rate
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
-10% -5% 0% 5% 10%
15%
20%
Capital Account Variation vs. 2003
Rea
l Exc
hang
e R
ate
2003
=1
Hard Peg
Intermediate
Floaters
28
Stylized facts of the last cycle What about the “total effect”?
CA Variation and ToT Shock vs. RER2003-2007
0.5
0.6
0.7
0.8
0.9
1.0
1.1
-15%
-10% -5% 0% 5% 10%
15%
20%
Terms of Trade Gains and CA Variation as % of GDP vis-a-vis 2003
Rea
l Exc
hang
e R
ate
2003
=1
CA Variation and ToT Shock vs. RER(cumulative 2004-07 gains and REER variation)
Uru
Per
Par
Mex Jam
Gua Dr
Col
Chi
Bra
Ven
Nic
Hon
Cri
Bol
Arg
Pan
SlvEcu
-60%
-50%
-40%
-30%
-20%
-10%
0%
-40%
-30%
-20%
-10% 0% 10%
20%
30%
40%
50%
Terms of Trade Gains and CA Variation as % of GDP vis-a-vis 2003
Rea
l Exc
hang
e R
ate
2003
=1
There is evidence of a negative correlation between the total foreign exchange flows and the real exchange rate
29
Stylized facts of the last cycle Where aggregate demand policies also expansionary?
Credit to the Private Sectoras % of GDP
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
Hard Peg Intermediate Floaters
2004 2005 2006 2007
Credit to Private Sector vs. Real Exchange Rate
Uru
Per
Par
Mex Jam
Gtm Dr
Col
Chi
Bra
Ven
Nic Hon
Cri
Bol
Arg
Pan
SlvEcu
-60%
-50%
-40%
-30%
-20%
-10%
0%
-50% 0% 50%
100%
150%
200%
Credit to the Private Sector as % of GDP variation between 2003 and 2007
Rea
l Exc
hang
e R
ate
varia
tion
betw
een
2003
and
200
7
There is a negative relationship between the growth in domestic credit during this period and the real exchange rate
This could have been one additional factor underlying the real appreciation of the currency.
30
Stylized facts of the last cycle Where aggregate demand policies also expansionary?
The degree of prudence in fiscal management was not related with the exchange rate regime
Fiscal Accounts Primary Expenditures - Primary Balance as % of GDP,
cumulative between 2007/8 and 2003
-5%-3%-1%1%3%5%7%9%
11%13%15%
Chile
Bol
ivia
El S
alva
dor
Peru
Para
guay
Gua
tem
ala
Uru
guay
Pana
ma
Hon
dura
sCo
lom
bia
Cost
a R
ica
Vene
zuel
aA
rgen
tina
Dom
inic
anN
icar
agua
Mex
ico
Bra
sil
Ecua
dor
31
Stylized facts of the last cycle Did the exchange rate made a difference?
Real Exchange Rate and Exchange Rate Regime
Dependant variable: Real Exchange Rate (Index number, 2003=100)Method: Random Effects GLS Panel Regression
Float Regime Dummy Variable -0.158***(0.034)
Terms of Trade Gains as % of GDP -0.356*and Capital Account variation vs. 2003 (0.240)
Credit as % of GDP -0.002***(0.000)
Note: Standard Error in parenthesis. *Significant at 15%, **Significant at 5%, ***Significant at 1%.
32
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
33
Commodity prices and agflationThere is a strong and possitive correlation between overall CPI
inflation and food inflation
Correlation between CPI and Food Inflation 4 quarters as of IIQ2008
UruPer
Par
Mex
GuaDom
Col
Chi
Bra
Ven
Nic
Hon CRi
Bol
Arg
Pan
SalEcu
0%
5%
10%
15%
20%
25%
30%
35%
0% 10% 20% 30% 40% 50% 60%
Food inflation
CPI
infla
tion
34
Commodity prices and agflationThere is now correlation between ToT shock and CPI, meaning that the income effect of the shock was not important in terms
of aggregate demand
Correlation between ToT shock and CPI Inflation 4 quarters as of IIQ2008
-2%
0%
2%
4%
6%
8%
10%
12%
14%
-20% -10% 0% 10% 20%
ToT shock IIIQ07-IIQ08
Chan
ge in
CPI
infla
tion
35
Commodity prices and agflationThere is evidence that the de facto exchange rate regime was
important on the inflation rate
Correlation between Regime and CPI inflation4 quarters as of IIQ2008
Uru
PerPar
Mex
Jam
GuaDom
Col
Chi
Bra
VenNic
Hon
CRi
BolArg
Pan
Sal
Ecu
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
-2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0%
Regime Formula A
Chan
ge in
infla
tion
IIQ
07-
IIQ
08
36
Commodity prices and agflationThe econometric analysis confirms that the exchange rate
regime did have an effect on inflation
Agflation and Exhange Rate RegimeDependant variable: Inflation (annual variation of CPI)Method: Fixed Effects Panel Data
Regime Formula 1.295**(0.656)
Terms of Trade Gains as % of GDP -0.027(0.152)
Agriculture Commodity Prices 0.560***(0.718)
Note: Std error in parenthesis. **Significant at 5%, ***Significant at 1%.
37
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
38
Effects of the last cycle and policy responses
The global financial crisis, which led to a reversal in the terms of trade and large capital outflows, represented a new policy challenge
In the first phase of the crisis (before Lehman), commodity prices were still high, and LAC countries were doing well and were still fighting inflation with high interest rates
After Lehman, the entire global financial system collapse and the crisis hit commodity prices and LAC economic activity. Some LAC countries had room to run countercyclical fiscal and monetary policy
39
Effects of the last cycle and policy responses
Regarding monetary policy, the exchange rate regime made a difference: Floaters allowed the exchange rate to depreciate because the capital outflows and sharp decrease in commodity prices. This depreciations did not have an impact on inflation.
Formal inflation targeters with almost pure free-floating regimes (Brazil, Chile, Colombia, Mexico and Peru) put the tightening cycle on hold during the last months of 2008 and they started cutting the policy rates in January 2009 to fight the economic downturn and help financial stability
The hard pegs could not and did not use monetary policy during the crisis, as the economies were fully dollarized
Intermediate regimes adopted a policy of “controlled” depreciation of their currencies during the crisis, but were forced to allow increases in domestic nominal interest rates to sustain the demand for domestic currency
40
Effects of the last cycle and policy responsesCommodity bust and monetary policy
41
Motivation and Purpose of the Paper
Analytical Framework
Methodology
Stylized facts of the last cycle
Commodity prices and agflation
Macroeconomic effects of the last cycle and policy responses
Final remarks and conclusions
Outline
42
There is evidence that countries in the region experienced the so called “Dutch disease”
The exchange rate system made a difference for the adjustment process:
Final remarks and conclusions
Countries with floating exchange rate systems experienced more real appreciation during the boom years than those that had hard pegs or intermediate regimes
Countries with managed floats suffered more inflation
During the reversal, the floaters were able to adjust RER much faster (there was also some overshooting of the NER) and to sharply reduce nominal interest rates
Countries with less flexible regimes were not able to reduce interest rates and some of them were forced to increase rates to limit capital outflows
43
The evidence suggests that the regime also made a difference regarding agflation:
Final remarks and conclusions
Countries with floating regimes were more successful in limiting the impact of the rise in commodity prices, as they compensated the increase in international prices through nominal appreciaton of their currencies
In sum: In this period more exchange rate flexibility implied less inflation during the boom years, more capacity to run countercyclical monetary policy but also much more volatility in the real exchange and a much faster transmission from commodity prices to Dutch disease
The intermediate regimes responded more slowly to the pressures on relative prices and hence the could smooth the real appreciations that took place primarily through inflation, and hence required a smaller “swing” when the cycle changed from boom to bust.
44
Can Fiscal Policy be used to avoid the “Dutch Disease”?
Final remarks and conclusions
In emerging market countries a countercyclical fiscal stance could in the end become a pro-cyclical policy
Larger fiscal surplus that is intended to reduce aggregate demand could induced capital inflows which offset the fiscal adjustment
Are there any options?
Commodity stabilization funds Could be hard to implement (complex policy issues)
Foreign exchange or capital controls