Latin America’s Experience with Fiscal Policy

Large fiscal buffers enabled many Latin American countries to respond to global crisis

But higher spending was not reversed as growth recovered

Key priorities: rebuild fiscal space to weather growth slowdown, restore stronger institutions

To weather the commodity cycle and other growth shocks, Latin America needs to rebuild fiscal buffers and strengthen fiscal institutions.

A new Staff Discussion Note—Fiscal Policy in Latin America: Lessons and Legacies of the Global Financial Crisis—looks at the region’s fiscal policy experience during the crisis and its aftermath. It focuses on the six larger, financially-integrated emerging market economies of Latin America—Brazil, Chile, Colombia, Mexico, Peru, and Uruguay—which account for more than 70 percent of the region’s output.

Incomplete reversal

The study finds that the 2009 fiscal stimulus reduced output losses in these six countries by ¾ to 2 percentage points. More than six years later, however, cyclically-adjusted fiscal balances in most of the region are well below pre-crisis levels, even with the benefits of sizeable commodity revenues and strong growth in the years following the crisis (see Chart 1). And spending-to-GDP ratios are about 4 percentage points of GDP higher than in 2007, on average, mainly reflecting increases in current spending that have proved hard to reverse as growth recovered.

Crisis legacies

The resulting loss of fiscal space is now becoming a pressing concern, as the commodity cycle has turned and growth in emerging market economies weakens, the study warns. And this is occurring while public finances are already set to come under pressure over the medium term from aging populations and increasing demands for public services. In some cases, policymakers are becoming constrained in their ability to mount a proactive fiscal response in the face of an adverse growth shock while others are even being pushed toward a fiscal tightening that may exacerbate the economic cycle.

Another legacy of the crisis has been some erosion of fiscal policy institutions. Initially, many countries had to “bend their fiscal rules” to accommodate the 2009 fiscal stimulus. Subsequently, however, the relaxation of the fiscal frameworks became de facto permanent, underscoring the risks of making ad hoc changes to the framework without a medium-term anchor or exit plan.

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