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Growth, Integration, and Macroeconomic Policy Design: Some Lessons for Latin America

David Begg

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: Even the richest countries face the ongoing challenge of how to combine monetary and fiscal discipline with sustainable growth. Increasingly, it is recognized that growth requires not merely factor accumulation but the appropriate market and political institutions. Rich countries are rich partly because of their past success in resolving these issues. This paper gives an overview of economic performance in Latin America, showing output growth, inflation, and the evolution of budget deficits. Then, it introduces a simple model, based on Begg (2000, 2001), capturing the interaction of macroeconomic policy and structural reform. Reform is costly today but improves future opportunities. These benefits may apply to means or variances. By increasing robustness to shocks, reforms that enhance labor market flexibility reduce the variance of output. Other reforms, by affecting means not variances, reduce systematic distortions that depress potential output. Finally, it examines the optimal speed of reform under different macroeconomic regimes, and hence isolates the effects of the choice of regime on the pace of reform. In general, in more distorted countries (or regimes) the benefit of reform is greater. Hence, regimes that inefficiently mitigate distortions should induce faster reform. Consequently, if dollarization or other policy changes reduce distortions, they should (optimally) slow the pace of reform.

Date: 2002-12
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