Latin America: When Is Fiscal Stimulus Right?

• Author: Nicolás Eyzaguirre/Benedict Clements/Jorge Canales-Kriljenko
• Position: Director of the IMF’s Western Hemisphere Department/Division Chief of the IMF’s Western Hemisphere Department/Senior Economist
• Pages: 48-49

Page 48

For some countries stimulus is appropriate during the global economic crisis. But for others the answer is less clear

THE role of fiscal policy in ameliorating the adverse effects of the global economic downturn is at the center of the policy debate in Latin America, as it is in other parts of the globe. Economic growth in the region is projected to decline from a healthy 4 percent in 2008 into negative territory in 2009, reversing some of the impressive gains in employment and poverty reduction of recent years. Fiscal, or government, revenues are also coming under pressure, making it difficult for countries to achieve targets for budget deficits, even without new spending initiatives. At the same time, many countries are constrained by limited access to financing and still-high levels of public debt, making it difficult to expand public borrowing. In these circumstances, how do policymakers assess whether or not a fiscal stimulus is appropriate? Under what conditions are markets likely to permit this kind of fiscal expansion to be effective in helping support living standards during a period of economic downturn?

Fiscal effects of the downturn

The contraction in economic activity and falling commodity prices are placing substantial pressure on government revenue. After several years of increases, revenue-to-GDP ratios for Latin American countries, on average, are projected to fall by about 2 percentage points of GDP in 2009 (see chart). The revenue declines among commodity producers are especially noteworthy. Fiscal revenues are likely to drop significantly below their estimated long-run levels, and a key issue is whether it is desirable and feasible to protect public spending from falling as well.

In deciding on the appropriate fiscal stance, an important consideration for policymakers is the effect of the budget deficit on financing conditions and interest rates. An increase in the government’s budget deficit raises the demand for funds and public debt levels, and under some circumstances may raise interest rates substantially.

In emerging markets in Latin America, the effects of higher budget deficits on interest rates are potentially much stronger than in advanced economies. Many governments have yet to establish credible medium-term, typically three-to five-year, fiscal frameworks to assure markets...