Why Did Macro Policy in Emerging Market Countries Improve?

The resilience of emerging market economies severely hit by the panic of 2008 is amazing, especially in comparison with the long emerging market crisis period of a decade ago.

I have written that the main explanation for this resilience is improved macroeconomic policy which was put in place in the years before the crisis in many of these countries: higher foreign reserves, lower inflation, reduced borrowing in foreign currencies, and a better fiscal position. But what was the underlying reason for these improvements? Certainly policy makers in the countries deserve credit, but changes in international economic “rules of the game” provided the necessary political and economic incentives.

Recall that the Mexican crisis of 1994-95 lead to large bailouts of the holders of Mexican dollar-linked government bonds by the IMF and the U.S. Treasury. At the time, many expressed concern about the moral hazard and the policy unpredictability caused by these bailouts. Expectations of such bailouts would increase risk taking on the part of investors and reduce incentives for emerging market countries to take steps to avoid circumstances that might lead to crisis. Some worried that the bailout philosophy could lead to more severe crises in the future, and they made proposals to establish a new international framework for limiting bailouts. The British and Canadian governments proposed putting limits on access to large scale loans from the IMF, but the United States resisted their proposals, so no agreement could be reached.

Without such a framework interventions were erratic. Emerging market crises got worse and continued for another eight years. There was the Asian financial crisis and the Asian contagion with Korea, Thailand, Indonesia, and Malaysia. There was the Russian crisis with global contagion to Brazil and Argentina and even the United States as the Fed cut the interest rates in response. The erratic nature of the interventions was very visible in the case of Russia. After several years of support, loans were suddenly pulled in August 1998.

But eventually a solution to the impasse was found in the creation of an alternative to IMF bailouts. The alternative was to add new clauses to the sovereign bonds—collective action clauses—which allowed for orderly workouts of sovereign debt problems between a country and its creditors. The alternative made it credible for the IMF to impose limits and abide by them.

People were skeptical that such clauses could be put into the bonds, but Mexico proved the naysayers wrong and went ahead and issued such bonds on February 26, 2003 (seven years ago last Friday) and many others countries followed Mexico. Agustin Carstens, now Finance Minister of Mexico, played a key role in the effort. As soon as these clauses were put into the bonds, the IMF and its shareholders agreed to establish a new “exceptional access framework.” Soon after the emerging markets moved into a new era of stability. Crises generated by emerging market countries diminished sharply. The countries became more resilient to shocks from abroad, as we saw in the recent crisis. It is hard to prove cause and effect in economics, but in my view these limits played a role by making large scale bailouts less likely and thereby providing incentives to emerging market countries to follow policies which would reduce the chance of crisis.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

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