Latin America is growing fast and fundamentals look healthier. Are these achievements here to stay? Strong commodity prices may not last forever and a US recession could have major repercussions in the region. Should countries prepare now for tomorrow's crisis? What is the top-ten list on the policy agenda? This report's aim is to present an alternative perspective in order to avoid either complacency or the "irrational exuberance" famously noted by Alan Greenspan, instead bringing into focus the macroeconomic policy challenges that logically follow from this alternative perspective. Our hope is that both policymakers and multilateral organizations will find this material stimulating enough to precipitate a useful-and in our view, necessary-debate.

While the pandemic lasts, Latin America and the Caribbean (LAC) will go through a tunnel full of uncertainty. It is not known especially how long it is: how long until therapies or a vaccine emerge, or until best practices are known to control the pandemic to live with a virus of unknown lethality. This note describes policy options on how countries can expand their possibilities to meet the economic challenges of the crisis, with an emphasis on growth and equity. These options are based on the assumption that the fiscal situation of the region and its access to sovereign credit markets are much more restricted than in previous crises, which forces to think about policy reforms beyond fiscal ones to accelerate the Economic recovery. The options are ambitious, but the ambition meets the need. This document is part of a series of 3 IDB monographs on public policies in the context of COVID-19. The other documents can be consulted at the following links: Public Policy to Tackle COVID-19: Recommendations for Latin America and the Caribbean: https://publications.iadb.org/en/public-policy-to-tackle-covid-19-recommendations-for--latin-america-and-the-caribbean From Lockdown to Reopening: Strategic Considerations for the Resumption of Activities in Latin America and the Caribbean within the framework of Covid-19 https://publications.iadb.org/en/from-lockdown-to-reopening-strategic-considerations-for-the-resumption-of-activities-in-latin-america-and-the-caribbean-within-the-framework-of-covid-19

This pamphlet excerpts a chapter on macroeconomic policy from the Poverty Reduction Policy Sourcebook, a guide prepared by the World Bank and the IMF to assist countries in developing and strengthening their poverty reduction strategies. It probes the relationship between macroeconomic policy matters, such as growth and inflation, and the fight against poverty, explains how sound monetary and fiscal policies--key tools of the macroeconomist--can help to spur growth and ease poverty.

Over the last decade, empirical studies analyzing macroeconomic conditions that may affect the size of government spending multipliers have flourished. Yet, in spite of their obvious public policy importance, little is known about public investment multipliers. In particular, the clear theoretical implication that public investment multipliers should be higher (lower) the lower (higher) is the initial stock of public capital has not, to the best of our knowledge, been tested. This paper tackles this empirical challenge and finds robust evidence in favor of the above hypothesis: countries with a low initial stock of public capital (as a proportion of GDP) have significantly higher public investment multipliers than countries with a high initial stock of public capital. This key finding seems robust to the sample (European countries, U.S. states, and Argentine provinces) and to the identification method (Blanchard-Perotti, forecast errors, and instrumental variables). Our results thus suggest that public investment in developing countries would carry high returns.

"Using a sample of 32 developed and developing countries we analyze the empirical characteristics of sudden stops in capital flows and the relevance of balance sheet effects in the likelihood of their materialization. We find that large real exchange rate (RER) fluctuations coming hand in hand with Sudden Stops are basically an emerging market (EM) phenomenon. Sudden Stops seem to come in bunches, grouping together countries that are different in many respects. However, countries are similar in that they remain vulnerable to large RER fluctuations be it because they could be forced to large adjustments in the absorption of tradable goods, and/or because the size of dollar liabilities in the banking system (i.e., domestic liability dollarization, or DLD) is high. Openness, understood as a large supply of tradable goods that reduces leverage over the current account deficit, coupled with DLD, are key determinants of the probability of Sudden Stops. The relationship between Openness and DLD in the determination of the probability of Sudden Stops is highly non-linear, implying that the interaction of high current account leverage and high dollarization may be a dangerous cocktail"--NBER website

We offer an alternative explanation for the fall of Argentina's Convertibility Program based on the country's vulnerability to Sudden Stops in capital flows. Sudden Stops are typically accompanied by a substantial increase in the real exchange rate that breaks havoc in countries that are heavily dollarized in their liabilities, turning otherwise sustainable fiscal and corporate sector positions into unsustainable ones. In particular, we stress that the required change in relative prices is larger the more closed an economy is in terms of its supply of tradable goods. By contrasting Argentina's performance relative to other Latin American countries that were also subject to the Sudden Stop triggered by the Russian crisis of 1998, we identify key vulnerability indicators that separated Argentina from its piers. We also provide an explanation for the political maelstrom that ensued after the Sudden Stop, based on a War of Attrition argument related to the wealth redistribution conflict triggered by the Sudden Stop and fiscal collapse. This framework also provides elements to rationalize the banking crisis that accompanied the fall of Convertibility.

Using a sample of emerging markets that are integrated into global bond markets, we analyse the collapse and recovery phase of output collapses that coincide with systemic sudden stops, defined as periods of skyrocketing aggregate bond spreads and large capital flow reversals. Our findings indicate the presence of a very similar pattern across different episodes: output recovers with virtually no recovery in either domestic or foreign credit, a phenomenon that we call Phoenix Miracle, where output "rises from its ashes", suggesting that firms go through a process of financial engineering to restore liquidity outside the formal credit markets. Moreover, we show that the US Great Depression could be catalogued as a Phoenix Miracle. However, in contrast to the US Great Depression, EM output collapses occur in a context of accelerating price inflation and falling real wages, casting doubts on price deflation and nominal wage rigidity as key elements in explaining output collapse, and suggesting that financial factors are prominent for understanding these collapses.