## wreo0518

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### Preface — preparation and global outlook
- Prepared by a team led by Hamid Faruqee and S. Pelin Berkmen under the overall direction and guidance of Alejandro Werner and Krishna Srinivasan; team members listed in source.
- Report reflects developments and staff projections through early March 2018.
- Global growth and revisions:
  - Global growth for 2017 is now estimated at 3.8 percent, 0.2 of a percentage point higher than projected last fall.
  - Global growth revised up to 3.9 percent for both 2018 and 2019 (0.2 of a percentage point higher than October 2017 forecast).
  - Advanced economies: growth revised up to 2.5 percent in 2018 and 2.2 percent in 2019.
  - Emerging market and developing economies aggregate: 4.9 percent for 2018 (unchanged) and 5.1 percent for 2019 (revised up by 0.1 of a percentage point).
  - China projected to decline from 6.9 percent in 2017 to 6.4 percent in 2019 (higher by 0.1 percentage point relative to October 2017).
  - Medium-term global growth projected to decline to around 3.7 percent.
- Near-term momentum drivers:
  - Expansionary US fiscal policy (accounting for half of the global growth upgrade for 2018–19).
  - Favorable global financial conditions, improved external demand, investment recovery in advanced economies, acceleration of private consumption in emerging markets, and improved conditions for commodity exporters.
- Risks:
  - Near-term risks broadly balanced; medium-term risks skewed to the downside.
  - Downside risks include sharp tightening of financial conditions, escalating trade tensions and protectionism, waning support for global economic integration, geopolitical strains, and vulnerability to an inflation surprise forcing more aggressive monetary tightening.

### Stock market volatility, global risks, and policy priorities (VIX)
- Market and risk observations:
  - Continued easy financial conditions despite monetary normalization could lead to reach-for-yield and buildup of vulnerabilities.
  - Illustrative protectionism scenario: a 10 percent increase in import prices everywhere could lower global output and consumption by about 1¾ percent after five years.
  - Changes in US tax policies expected to exacerbate income polarization.
  - Noneconomic risks include geopolitical tensions, political uncertainty in Latin America, weak governance, systemic corruption, and more frequent extreme weather events.
- Global policy priorities:
  - Raise growth potential and inclusiveness: lift labor productivity, increase labor force participation, support displaced workers.
  - Rebuild global countercyclical buffers and fiscal space; contain financial market risks to increase resilience.
  - In EMDEs, improve monetary frameworks to lower core inflation and provide scope to support demand; pursue governance reforms and economic diversification.

### United States: growth, policy mix, and spillovers
- Recent performance and forecasts:
  - 2017: seasonally adjusted annual real GDP grew slightly over 3 percent in 2017:Q2 and Q3; 2017:Q4 at 2.5 percent; whole-year growth 2.3 percent (up from 1.5 percent in 2016).
  - Core personal consumption expenditure inflation at 1.5 percent.
  - Average hourly earnings up 2.5 percent over the past 12 months.
  - Economic activity projected to expand by 2.9 percent in 2018 and 2.7 percent in 2019 (up by 0.6 and 0.8 of a percentage point, respectively, compared to October 2017 WEO forecasts).
  - Inflation expected to rise to 1.9 percent by the end of 2018 and modestly overshoot the Federal Reserve’s target in 2019.
  - Current account deficit projected to deteriorate to 2.9 percent of GDP in 2018, peaking at 3.6 percent of GDP in 2020.
  - General government debt projected to rise to 110 percent of GDP by 2020.
- Tax Cuts and Jobs Act (TCJA) key features and macro implications:
  - Statutory corporate income tax rate lowered from 35 to 21 percent.
  - Temporary capital expensing through 2023; phased out by 2027.
  - Interest deduction capped at 30 percent of EBITDA until 2022, then 30 percent of EBIT; unused deductions can be carried forward.
  - Pass-through entities: 20 percent exemption on incomes before individual rates.
  - Move toward territorial system with guardrails: one-time repatriation tax (15.5 percent on cash and cash equivalents; 8 percent on other assets), FDII effective tax rate 13.125 percent (16.4 percent after 2025), GILTI effective tax rate 10.5 percent (rising to 13.125 percent after 2025), base erosion anti-abuse tax minimum 10 percent (12.5 percent after 2025).
  - Personal tax changes: top marginal rate 39.6 to 37 percent; standard deduction roughly doubled (from $13,000 to $24,000 for joint filers); child tax credit increased from $1,000 to $2,000; many personal measures sunset after 2025.
  - Macroeconomic impact: estimated cumulated level effect on real GDP of 1.2 percent through 2020; changes contribute about half of the cumulative revision to global growth over 2018–19.
- Policy risks and priorities:
  - Fiscal stimulus at full employment heightens risk of inflation surprise, faster Fed tightening, decompression of term premiums, stronger US dollar, and lower equity prices.
  - Policy priorities: strengthen regulatory system (including housing finance and insurance supervision), structural policies (education, healthcare coverage, trade regime), complementary social policies (childcare, paid family leave, earned income tax credit, minimum wage), and skills-based immigration reform.

### Canada: housing risks, policy stance, and recommendations
- 2017 performance and near-term outlook:
  - Canada grew by 3 percent in 2017 (highest G7 growth).
  - GDP growth expected to moderate to 2.1 percent in 2018 and 2 percent in 2019.
  - Medium-term potential growth limited to about 1¾ percent.
- Housing and mortgage dynamics:
  - House prices grew by about 16 percent in 2017.
  - Toronto house prices declined since mid-2017 after Ontario’s Fair Housing Plan (including 15 percent tax on nonresident buyers) and federal mortgage insurance rule changes.
  - Stress test for insured mortgages (late 2016) coincided with a drop in high loan-to-value mortgages by about 5½ percent in 2017 and acceleration of low loan-to-value mortgages growth to about 17 percent.
  - Share of low-ratio mortgages with loan-to-income ratios greater than 450 percent rose to 32 percent in 2016 (from 23 percent in 2014); about 30 percent of these loans to households under 35; 44 percent to lowest-income households.
  - Regulatory change for noninsured mortgages (effective January 2018) introduces restrictions on multiple-source borrowing, stricter loan-to-value measurement accounting for price risks, and a stress test for noninsured mortgages; qualifying rate set at greater of contractual rate plus 2 percentage points or the five-year benchmark rate published by the Bank of Canada.
- Policy recommendations:
  - Monetary policy: Bank of Canada raised policy rate three times since July 2017 (by 75 basis points to 1.25 percent); IMF projects gradual increase toward neutral around 3 percent; tighten only gradually given US policy uncertainty.
  - Fiscal policy: no additional fiscal stimulus; federal government should start rebuilding fiscal buffers gradually as envisaged in the 2018 budget; Ontario intends deficit about ¾ percent of Ontario’s GDP over next three fiscal years.
  - Macroprudential: hold off on additional measures until effects of recent measures are known; address housing supply constraints (zoning, approval processes, transit).
  - Structural reforms: review overall tax system before major tax reform; accelerate Canadian Free Trade Agreement implementation; reduce FDI restrictions and regulatory barriers; diversify trade patterns.

### Latin America and the Caribbean (LAC) outlook and policy priorities
- Regional growth projections (implicit year labels):
  - 2016: –0.6
  - 2017: 1.3
  - 2018: 2.0
  - 2019: 2.8
- Excluding Venezuela, average growth for region in 2017: 1.9 percent; Venezuela contracted by a further 14 percent in 2017.
- Private investment:
  - Stopped being a major drag in 2017 after three years of contraction; expected to move solidly into positive territory in 2018–19 and to be main driver of projected acceleration.
- External and domestic financial conditions:
  - Commodity prices partly rebounded since early 2016; net commodity terms of trade reverted to boom levels for some metal exporters.
  - Current account deficits narrowed in most countries recently, led mainly by improvements in private sector savings-investment balance.
  - Private credit doubled region’s credit-to-GDP ratio between 2005 and 2015 and has broadly stabilized; nonperforming loans rose during slowdown but remain manageable and well provisioned in most countries.
  - Inflation has come down sharply region-wide; unemployment rates have peaked in most countries and labor markets show improvement.
- Fiscal dynamics:
  - Sharp fall in commodity revenues post-super-cycle and upward trend in current spending led to deterioration in fiscal balances and debt ratios.
  - Policy responses: raising noncommodity revenues (Argentina, Chile, Mexico, Trinidad and Tobago) or cuts in public investment.
  - Regional public sector gross debt: 2015: 54.5; 2016: 57.8; 2017: 60.5; 2018 (Est.): 64.7; 2019 (Projections): 65.7 (Percent of GDP).
- Policy guidance for region:
  - Fiscal adjustment imperative: pace and composition should support inclusive growth and preserve productivity-enhancing spending; preserve public investment where possible.
  - Monetary policy: can provide support if inflation expectations remain anchored; strengthen central bank institutional and operational frameworks and communication.
  - Exchange rate flexibility remains first line of defense against external shocks.
  - Deep structural reforms needed: education, health, business environment, infrastructure, governance, and female labor participation.

### Country- and subgroup-specific notes and priorities
- South America:
  - Growth resumed in 2017 (average 0.7 percent, PPP); recovery expected in 2018–19 driven by Argentina and Brazil.
  - Policy: place debt on sustainable footing; front-load adjustment where sustainability/credibility at risk; use higher commodity revenues to reform.
- Selected country highlights (key figures preserved):
  - Argentina: Real GDP growth forecast 2.0 percent in 2018, 3.2 percent in 2019; severe drought to affect 2018 agriculture; primary fiscal deficit to decline; inflation expected to continue falling but at a slower pace.
  - Bolivia: Real GDP grew by 4.2 percent in 2017; projected to grow by 4 percent in 2018; expansionary policies financed by drawdown of savings and borrowing have left sizable fiscal and current account deficits likely to persist absent policy change.
  - Brazil: Real GDP expected to grow 2.3 percent in 2018; monetary policy to move gradually; fiscal consolidation continued in 2017; social security reform postponed—implementing it is important.
  - Chile: Growth revised up to 3.4 percent in 2018 (2017: 1.5 percent); monetary policy appropriately accommodative; wait for inflation convergence before normalizing.
  - Colombia: Growth lifted to 2.7 percent in 2018; investment to increase on infrastructure projects and oil sector; fiscal easing supported domestic demand.
  - Ecuador: Recovery supported by oil price rebound; vulnerabilities include weak fiscal position and low reserves; recommend front-loaded fiscal reform and structural reforms.
  - Paraguay: Expected to expand by 4½ percent in 2018; inflation pressures rising—gradually remove monetary accommodation; fiscal anchor operating well but constrain current primary spending growth.
  - Peru: Grew 2.5 percent in 2017; central bank cut policy rate six times since May 2017; growth expected to rebound to around 3¾ percent in 2018.
  - Uruguay: Growth expected to exceed 3 percent in 2018; save growth-related windfalls to safeguard 2019 fiscal deficit target of 2.5 percent of GDP.
  - Venezuela: Expected contraction by 15 percent in 2018 after cumulative 35 percent contraction over 2014–17; consumer price inflation estimated at about 2,800 percent in 2017 and projected about 13,000 percent in 2018; international reserves dropped to about $9.3 billion by end of January 2018; bonds in selected default.
  - Mexico: Output growth expected to accelerate from 2 percent in 2017 to 2.3 percent in 2018; inflation to converge toward 3 percent mid-2019; downside risk of NAFTA breakup.
- CAPDR and Caribbean:
  - CAPDR growth about 4 percent in 2017; remittances are the most important external flow.
  - Caribbean: tourism growth strong in several countries; hurricane recovery ongoing—Dominica GDP projected to decline by 16.3 percent in 2018 before rebounding in 2019.
  - Policy priorities: fiscal consolidation to rebuild buffers, strengthen pension systems where needed (Nicaragua), improve tax administration and broaden bases, protect vulnerable spending, preserve exchange rate flexibility, and strengthen AML/CFT to secure correspondent banking relationships.

### Central bank credibility, communication, and monetary procyclicality (Chapter findings)
- Empirical findings:
  - Analysis of 20 inflation-targeting economies to protracted terms-of-trade shocks (illustrative 20 percent decline).
  - Economies with less-anchored expectations (initial gap above 75th percentile) saw inflation expectation gap widen by 30 basis points following a terms-of-trade shock; most credible central banks saw no significant widening.
  - Where deterioration of inflation expectations is greater, policymakers raised policy rates more aggressively, leading to procyclical tightening amid weak growth.
  - Central banks with average LA5 transparency scores increased policy rate by 50 basis points for each 100 basis point increase in inflation after a terms-of-trade decline; a country with Australia’s transparency level kept policy rate unchanged after the same shock.
- Transparency framework elements linked to credibility:
  1. Formal policy objective (explicit quantification).
  2. Assessment of current state of the economy.
  3. Explanation of policy decisions.
  4. Forward-looking analysis.
  5. Publication of data and forecasts used for assessment.
- Communication quality findings:
  - Quality matters more than quantity; more readable press statements associated with lower forecast errors.
  - Chile exhibits high communication quality and credibility: reforms in September 2017 reduced frequency of events and increased content per event; estimated transparency score 11.5 on Dincer and Eichengreen scale.
  - Forward guidance and explicit policy "bias" improve transmission from policy rates to inflation expectations; Chile used policy bias about once every two meetings.
- Policy recommendations:
  - Strengthen transparency frameworks and communication quality to anchor expectations and reduce procyclicality.
  - Publish minutes, votes, and assessments of forecasting/operational performance where appropriate; extend horizons of expectation surveys.
  - Tailor transparency reforms to country-specific conditions, focusing reforms at low levels of transparency where marginal gains are largest.

### Fiscal multipliers and consolidation effects (Chapter findings and methodological notes)
- Meta and new estimates:
  - Review of 132 estimates: average multiplier for LAC = 0.3; other EMDEs = 0.6; advanced economies = 0.9.
  - New database estimates: fiscal multipliers in region estimated between 0.5 and 1.1 (after two years).
  - For a fiscal adjustment raising the primary balance by 1 percent of GDP, after two years output in the 14 LAC economy sample contracts by average 0.9 percent (90 percent confidence interval between 0.6 and 1.1).
  - Each percentage point of GDP in consolidation raises unemployment rate by about 0.3 percentage point after two years.
- Multipliers by instrument:
  - Public investment multiplier almost 1.5 after two years.
  - Primary expenditure multiplier 0.5 after two years.
  - Public consumption multiplier equals –0.6 after two years (interpretation problematic).
  - No compelling evidence of large differences between tax-hike and spending-cut multipliers in LAC.
- State dependence and confidence effects:
  - Consolidation in high perceived sovereign risk periods associated with smaller contractionary effect (multiplier 0.6 after two years) versus 1.1 in low-risk economies—consistent with confidence effects.
  - Multipliers broadly constant over business cycle with respect to output gap.
- Policy implications:
  - Consolidation will be contractionary in the short run; composition matters—preserve public investment where possible to support growth and employment.
  - Where sustainability or credibility at risk, front-load adjustment.
  - Well-designed, transparent consolidation can improve credibility and funding conditions.
  - Regional expected consolidation between 2016 and 2020: cyclically adjusted primary balance expected to improve by 1.4 percent of GDP.

### Poverty and inequality: gains in the commodity boom and uncertain outlook
- Aggregate and cross-country findings:
  - Latin America made impressive progress in reducing inequality and poverty since 2000 but remains the most unequal region globally.
  - Commodity exporters saw pronounced gains during the commodity boom; much progress reflected real labor income gains for lower-skilled workers, especially in services, with a smaller role for transfers.
  - End of commodity boom and tighter fiscal envelopes risk reversing social gains; poverty rates already edging up in some countries.
- Empirical and micro evidence:
  - Commodity exporters: income shares of deciles 2–8 increased significantly with higher commodity terms of trade; top decile share declined substantially on average; bottom decile income share not statistically significant though absolute income rose.
  - Shapley decompositions in Bolivia and Peru: labor income played larger role than transfers in reducing inequality and poverty.
  - Municipal-level evidence in Brazil and Bolivia: producer municipalities reduced poverty more than nonproducer municipalities (Brazil: producers reduced poverty by 1.4 percentage points on average; Bolivia: 2.7 percentage points more).
  - Brazil: one standard deviation increase in natural resource production per capita reduced poverty rate by 0.2 percentage point for most municipalities; top five producers saw reductions between 3 and 9 percentage points.
- Risks post-2014:
  - Employment growth slowed more in commodity exporters; real wage growth negative for all skill groups in 2015–16 annualized; poverty increased in some commodity exporters (Brazil, Paraguay); inequality largely moved sideways post-2014.
- Policy options to sustain social progress:
  - Maintain quality of social and infrastructure spending by increasing revenues and reprioritizing spending.
  - Increase progressive personal income tax revenues; reduce universal price subsidies.
  - Improve targeting of social transfers and efficiency of spending.
  - Use stabilization funds, reform revenue-sharing and decentralization to avoid local boom-bust cycles; build subnational capacity and own-revenue bases.
  - Labor market policies: retool workers, increase flexibility, continue structural reforms to diversify production base.
  - Human capital: prioritize quality improvements in education.

### Natural disasters, climate change, crime, and regional resilience (selected boxes)
- Natural disasters and IMF support:
  - Caribbean highly vulnerable to disasters (Hurricane Matthew 2016; Irma and Maria 2017).
  - Dominica recovery costs preliminarily estimated at "more than 200 percent of GDP."
  - IMF increased annual access limits under RCF and RFI to "60 percent of quota" for countries with large disasters (damages exceeding 20 percent of GDP); RCF loans interest rate "0 percent."
  - Disaster financing tools: fiscal buffers, insurance (CCRIF paid out "$55 million" after 2017 hurricanes), state-contingent clauses in sovereign debt (example: Grenada 2015).
- Crime and growth (CAPDR and Caribbean):
  - Homicide rates among highest globally; Honduras peaked at 87 per 100,000 in 2011 and halved to 43 per 100,000 by 2017.
  - Conviction rates for homicides averaged about 20 percent (2007–15) versus 40 percent globally.
  - Reducing crime to world average could raise GDP growth by around 0.4 percentage point a year in El Salvador, Jamaica, and Honduras.
  - Cumulative GDP losses due to high crime (1999–2015): El Salvador ~9½ percentage points; Honduras ~7½ percentage points; Jamaica ~7 percentage points.
  - Policy implications: combine growth policies, deterrence, justice-system strengthening, targeted youth programs, data collection, and skills training for convicts.
- Financial sector and macroprudential:
  - Recommendations: integrate systemic risk into supervision, transition to Basel III, strengthen consolidated supervision and cross-border coordination, and secure correspondent banking relationships via AML/CFT improvements.

*International Monetary Fund | April 2018 — Regional Economic Outlook: Western Hemisphere (wreo0518).*

### Preface v

### Preface v

### Preparation and contributors
- Prepared by a team led by Hamid Faruqee and S. Pelin Berkmen under the overall direction and guidance of Alejandro Werner and Krishna Srinivasan.
- Team members: Pablo Bejar, Carlos Caceres, Yan Carrière-Swallow, Antonio David, Carlos Gonçalves, Yurani Granada, Kotaro Ishi, Etibar Jafarov, Genevieve Lindow, Prachi Mishra, Jorge Restrepo, Galen Sher, Suchanan Tambunlertchai, Bert van Selm, Peter Williams, and Juan Yépez.
- Chapter-specific guidance and contributions:
  - Chapter 1: Nigel Chalk and Cheng Hoon Lim (guidance and review); Pelin Berkmen (preparation) with Kotaro Ishi and Suchanan Tambunlertchai; research assistance from Pablo Bejar, Yurani Granada (Canada section), and Peter Williams (US section).
  - Chapter 2: Kimberly Beaton, Javier Kapsoli, Gerardo Peraza, Uma Ramakrishnan, and Joyce Wong; Cristhian Vera and Lulu Shui (research assistance for Central America and Caribbean sections).
  - Chapter 3: Henrique Barbosa, Adrián Robles, and Banco de España team (Alberto Fuertes, Ricardo Gimeno, Jose Manuel Marques); Annex work by Takuji Komatsuzaki.
  - Chapter 4: Takuji Komatsuzaki contributed; Daniel Leigh provided guidance in preparation.
  - Chapter 5: Led by Ravi Balakrishnan; team composed of Frederik Toscani and Mauricio Vargas.
- Production and translation:
  - Production assistance led by Ravi Sundararajan (Western Hemisphere Department).
  - Editing and production coordinated by Linda Long (Communications Department).
  - Translation and editing for the Spanish edition led by Carlos Viel and Virginia Masoller, with administrative support from María Fraile de Manterola.
- Report reflects developments and staff projections through early March 2018.

### Executive summary highlights and global outlook
- Global growth and revisions:
  - Global growth for 2017 is now estimated at 3.8 percent, 0.2 of a percentage point higher than projected last fall.
  - Global growth is revised up to 3.9 percent for both 2018 and 2019 (0.2 of a percentage point higher than the previous forecast in October 2017).
  - In advanced economies, growth is revised up to 2.5 percent in 2018 and 2.2 percent in 2019.
  - Aggregate growth forecast for emerging market and developing economies: 4.9 percent for 2018 (unchanged) and 5.1 percent for 2019 (revised up by 0.1 of a percentage point).
  - China: growth projected to decline from 6.9 percent in 2017 to 6.4 percent in 2019 (higher by 0.1 percentage point relative to October 2017 projections).
  - Medium-term global growth projected to decline to around 3.7 percent.
- Drivers of near-term momentum:
  - Expansionary US fiscal policy (accounting for half of the global growth upgrade for 2018–19).
  - Favorable global financial conditions, improved external demand, investment recovery in advanced economies, acceleration of private consumption in emerging markets, and improved conditions for commodity exporters.
- Inflation and financial conditions:
  - Headline inflation has picked up with the increase in oil prices; core inflation has started to edge up, particularly in advanced economies.
  - Global financial conditions remain supportive despite market volatility episodes in February and March 2018; capital flows to emerging markets remain robust.
- Risks:
  - Near-term risks broadly balanced; medium-term risks skewed to the downside.
  - Downside risks include: a possible sharp tightening of financial conditions, escalating trade tensions and shifts toward protectionist policies, waning support for global economic integration, and geopolitical strains.
  - Vulnerability to an inflation surprise as output gaps turn positive, potentially forcing more aggressive monetary tightening and a sharper decompression of term premiums.

### Regional outlook: Western Hemisphere and policy priorities
- Latin America and the Caribbean:
  - Recovery gaining strength: following a contraction in 2016, growth moved solidly into positive territory in 2017 and is expected to accelerate further in the near term, supported by pickup in global demand and trade, accommodative global financial conditions, an uptick in commodity prices, and a cyclical recovery of domestic private investment.
  - Medium-term prospects remain weak: potential growth expected to revert to subdued long-run average; projected GDP per capita growth rates substantially below most other emerging market regions and just modestly above advanced economies.
  - Fiscal challenges: sharp fall in commodity revenues and widening fiscal deficits worsened debt dynamics; commodity prices expected to remain low for long, necessitating fiscal buffers and restored sustainability.
  - Policy guidance:
    - Fiscal adjustment imperative, with pace and composition tuned to support and protect inclusive growth and productivity-enhancing spending.
    - Monetary policy can remain accommodative provided inflation expectations remain anchored.
    - Exchange rate flexibility should remain the first line of defense against external shocks.
    - Deep and comprehensive structural reform agenda needed to boost potential growth and productivity.
- South America:
  - Growth resumed in 2017, supported by favorable external environment and cyclical recovery in domestic demand, with activity expected to accelerate in 2018 and 2019.
  - Policymakers should place public debt on a sustainable footing while minimizing adverse impacts on short- and medium-term growth; where fiscal sustainability or credibility are at risk, front-load adjustment and push through fiscal reform.
- Mexico, Central America, Panama, and the Dominican Republic; and the Caribbean:
  - Outlook shaped largely by developments in the United States because of trade, financial, and migration linkages.
  - Near-term benefits from higher US growth; longer-term uncertainties stemming from US policies.
  - Policies should preserve macroeconomic stability amid complex external environment and domestic electoral uncertainty (coming elections in Costa Rica and Mexico), while setting the stage for stronger, sustainable, and inclusive growth.
  - Tackling corruption and improving law enforcement and security remain imperative for sustained investment and private sector participation.

### Key findings from analytical chapters
- Central bank communication, transparency, and credibility (Chapter 3):
  - Procyclical monetary policy tightening in response to external supply shocks prompted reexamination of policy and public communication.
  - Central bank credibility—reflected in anchoring of inflation expectations—is positively related to central bank transparency.
  - Stronger transparency frameworks and communication strategies are associated with higher policy predictability and better anchoring of inflation expectations, providing greater room to maneuver against transitory shocks.
- Fiscal multipliers and consolidation (Chapter 4):
  - A new database of fiscal policy actions indicates estimated fiscal multipliers suggest consolidation in the region will be more contractionary than previously thought.
  - Multipliers are nevertheless small enough to suggest consolidations will improve debt dynamics even in the short run.
  - Since expenditure multipliers vary by instrument, consolidation plans should preserve public investment to support growth and employment.
- Poverty and inequality (Chapter 5):
  - Latin America made impressive progress in reducing inequality and poverty since the turn of the century but remains the most unequal region in the world.
  - Gains were particularly pronounced for commodity exporters during the commodity boom; much of the progress reflected real labor income gains for lower-skilled workers, especially in services, with a smaller positive role for government transfers.
  - With the end of the commodity boom, a tighter fiscal envelope, and poverty rates already edging up in some countries, policies must be carefully calibrated to sustain social progress.
  - Increasing personal income tax revenues while rebalancing spending can help maintain key social transfers and infrastructure spending.

*Preface v — Regional Economic Outlook: Western Hemisphere, International Monetary Fund | April 2018*

### 1. VIX

### 1. VIX

### Stock Market Volatility and Global Risks
- Figure references show measures of stock market volatility, equity indices (Index: January 2016 = 100), long-term bond yields (Percent), and portfolio flows to emerging markets (Four-week rolling sum; billions of US dollars).
- Continued easy financial conditions, despite the onset of monetary policy normalization, could lead to a further reach for yield and a buildup of financial vulnerabilities, leaving markets exposed to a sharp tightening of financial conditions.
- Additional risks:
  - Shift toward inward-looking policies and weakened support for globalization amid renegotiations of NAFTA and UK–EU arrangements.
  - Recent import restrictions and retaliatory actions (United States and China) could disrupt global supply chains, slow technology diffusion, lower consumer welfare, and complicate international cooperation.
  - Illustrative scenario: rising protectionism in all countries, leading to a 10 percent increase in import prices everywhere, could lower global output and consumption by about 1¾ percent after five years.
  - Changes in US tax policies expected to exacerbate income polarization.
  - Noneconomic risks: geopolitical tensions (East Asia, Middle East), political uncertainty (including upcoming elections in Latin America), weak governance and systemic corruption, and more frequent extreme weather events.

### Policy Priorities (Global)
- Need to raise growth potential and enhance inclusiveness via:
  - Measures to lift labor productivity.
  - Increase labor force participation.
  - Support the young and those displaced by global structural change in job search.
- Rebuild global countercyclical buffers to manage the next downturn.
- Contain financial market risks to increase financial resilience.
- Improve fiscal space to finance growth-friendly policies and put debt ratios on a downward trend.
- Fiscal policy should focus on medium-term objectives (including improving infrastructure) while ensuring public debt dynamics are sustainable and buffers rebuilt; where consolidation is needed, pace should avoid sharp growth drags.
- In EMDEs, improved monetary frameworks lower core inflation and provide scope to support demand if activity weakens; governance reforms and economic diversification (especially in commodity-exporting countries) to lift private investment and create jobs.

### US Outlook: Growth, Inflation, and Balance Sheet Projections
- 2017 performance:
  - Seasonally adjusted annual real GDP grew by slightly over 3 percent in the second and third quarters of 2017.
  - 2017:Q4 numbers came in at 2.5 percent.
  - For the whole year, growth was 2.3 percent, up from 1.5 percent in 2016.
- Inflation and labor:
  - Core personal consumption expenditure inflation at 1.5 percent (below the Federal Reserve’s 2 percent target).
  - Average hourly earnings up 2.5 percent over the past 12 months.
- Policy stimulus and forecasts:
  - Tax reform and the 2018 two-year bipartisan budget agreement boost GDP levels over the next two years.
  - Economic activity projected to expand by 2.9 percent in 2018 and 2.7 percent in 2019 (up by 0.6 and 0.8 of a percentage point, respectively, compared to the October 2017 WEO forecasts).
  - Inflation expected to rise to 1.9 percent by the end of 2018 and modestly overshoot the Federal Reserve’s target in 2019.
  - Current account deficit projected to deteriorate to 2.9 percent of GDP in 2018, peaking at 3.6 percent of GDP in 2020.
  - General government debt projected to rise to 110 percent of GDP by 2020.

### US Policy Mix, Risks, and Priorities
- Fiscal policy:
  - Key TCJA features: temporary cuts in the personal income tax and significant and permanent cuts in the corporate income tax.
  - The recent two-year budget bill increases spending authority by $300 billion over the next two years.
  - The primary structural general government balance is estimated to weaken from –2.5 percent in 2017 to –3.9 percent of potential GDP by 2019.
  - Tax reform will lead to revenue losses and increase federal debt by about 5 percentage points of GDP in the next five years.
  - After 2021, fiscal stimulus is expected to move into reverse, acting as a drag on the economy and resulting in growth falling below potential.
- Monetary policy:
  - The Federal Open Market Committee raised the federal funds rate target range by 25 basis points to 1½ to 1¾ percent in March 2018.
  - The Federal Reserve’s gradual balance sheet normalization, announced in September 2017, has proceeded as planned with muted effects so far; the Fed will continue to be active in Treasury and mortgage-backed securities markets while stepping up the pace of balance sheet reduction later in 2018 and into 2019.
- Increased upside and downside risks:
  - Fiscal stimulus at full employment heightens the risk of an inflation surprise, faster-than-expected Fed tightening, decompression of term premiums, stronger US dollar, and lower equity prices.
  - Eventual withdrawal of fiscal stimulus when policy rates are likely above neutral could trigger a sharper-than-expected slowdown with global spillovers.
- Policy priorities:
  - Strengthen regulatory system (including housing finance and insurance supervision) while preserving the current risk-based approach to regulation, supervision, and resolution.
  - Structural policies to maintain a productive and flexible workforce and reduce income inequality: improve educational opportunities and outcomes; protect health care coverage gains; maintain a free, fair, and mutually beneficial trade and investment regime; contain health care cost inflation.
  - Complementary policies: childcare support for low- and middle-income families, paid family leave, expanded earned income tax credit, increased federal minimum wage, and better social assistance programs.
  - Skills-based immigration reform to address demand for skilled labor, enhance labor productivity, lift potential growth, and ameliorate medium-term fiscal imbalances from population aging.

### US Policy Uncertainties Highlighted
- Financial deregulation:
  - Proposals to roll back provisions of the Dodd-Frank Act vary; simplifying frameworks for small and medium-sized banks has broad support, but rolling back prudential standards for large systemic banks could rebuild financial stability risks.
- Trade policy:
  - NAFTA renegotiations ongoing; several US proposals (minimum US content requirements, eliminating dispute resolution, government procurement cap, five-year sunset clause) are major points of contention.
  - Recent US steps: safeguards on imports of washing machines and solar panels; proposed tariffs on steel and aluminum; announced trade actions over China’s intellectual property practices.
  - Worsening trade tensions and broader barriers would directly and indirectly weaken economic activity and confidence.
- Immigration policy:
  - Immigrants make up around 14 percent of the US population, and 17 percent of the US workforce (US Census Bureau).
  - Interruptions to immigrant inflows would reduce US workforce growth and weigh on growth, especially given expected expansion through full employment.

### Canada: Growth, Outlook, and Risks
- 2017 performance:
  - Canada grew by 3 percent in 2017, the highest growth rate among G7 economies in 2017.
  - Private consumption strong for the first three quarters, supported by gains in disposable income; employment rate increased and unemployment fell to its lowest level in 40 years.
  - Business investment grew for the first time since 2014 but moderately; residential investment accelerated in 2017:Q4 ahead of tighter underwriting guidelines in January 2018.
- Near-term and medium-term outlook:
  - GDP growth expected to moderate to 2.1 percent in 2018 and 2 percent in 2019, above the economy’s medium-term potential.
  - Canada’s medium-term potential growth limited to about 1¾ percent due to weak external competitiveness, sluggish labor productivity growth, and population aging (compared with recent average of 2.6 percent over 2000–08).
  - Medium-term prospects clouded by changes in US tax and trade policies.
- Effects of US policy on Canada:
  - US tax reform expected to temporarily boost Canada’s near-term growth by around 0.2 to 0.3 percentage point.
  - Over the medium term, a lower US tax burden on business investment could draw investment away from Canada.
  - NAFTA negotiations: some modernization progress, but US proposals (minimum US content, eliminating dispute resolution, procurement caps, five-year sunset) are contentious. NAFTA uncertainty is already weighing on investment in Canada; failure to reach agreement could have prolonged investment impacts.

### Canada: Inflation and Housing Vulnerabilities
- Inflation:
  - After decelerating toward the lower bound of the Bank of Canada’s 1–3 percent target range in mid-2017, all three core CPI inflation measures and headline inflation recovered and currently hover around 2 percent (midpoint).
- Housing market vulnerabilities:
  - Household debt as a percentage of disposable income reached a historic high of 173 percent at the end of 2017.
  - Banks’ exposures to households account for about one-third of bank assets.
  - Financial stability risks could emerge if a sharp housing correction occurred together with a sharp and persistent rise in unemployment.
  - Macroprudential policy and tax measures have cooled housing markets, but durability is uncertain.
  - Example: In Vancouver, federal macroprudential measures plus a provincial tax on nonresident home buyers introduced in August 2016 contributed to a softening in the housing market, with house prices falling about 3½ percent between August and December.

*Source: wreo0518 - 1. VIX (Regional Economic Outlook: Western Hemisphere, International Monetary Fund | April 2018).*

### 2016. However, price pressures have since

### wreo0518 - 2016. However, price pressures have since

### Housing market developments and mortgage risk in Canada
- House prices grew by about 16 percent in 2017.
- In Toronto, house prices have fallen since the middle of 2017. Ontario’s Fair Housing Plan (announced in April 2017), which included a 15 percent tax on nonresident home buyers, together with changes in mortgage insurance rules at the federal level, contributed to a dampening in market sentiment and a decline in house prices.
- Following the introduction of a stress test for insured mortgages in late 2016:
  - High loan-to-value-ratio mortgages dropped by about 5½ percent in 2017.
  - Growth of low loan-to-value-ratio mortgages accelerated to about 17 percent.
- There is some concern that low loan-to-value ratio mortgages have increasingly been taken by households with higher levels of risk:
  - The share of low-ratio mortgages with loan-to-income ratios greater than 450 percent rose to 32 percent in 2016 (most recent data available), up from 23 percent in 2014.
  - About 30 percent of these loans are to younger households (under 35 years old).
  - 44 percent are loans to the lowest-income households.
- Regulatory change for noninsured mortgages (effective January 2018) follows previous measures; key revisions to guidelines include:
  - Restrictions on borrowing from multiple sources.
  - Stringent requirements for the measurement of loan-to-value ratios by taking account of housing market risks (for example, price risks).
  - Introduction of a stress test for noninsured mortgages as was introduced for insured mortgages in late 2016.
- Federally regulated financial institutions must set the qualifying rate for noninsured mortgages at the greater of the contractual mortgage rate plus 2 percentage points or the five-year benchmark rate published by the Bank of Canada.

### Policy priorities for Canada
- Monetary policy:
  - The Bank of Canada has raised the policy rate three times since July 2017 (by 75 basis points to 1.25 percent).
  - IMF staff projects a gradual increase of the policy rate toward its neutral level (around 3 percent) over the projection horizon.
  - Given elevated uncertainty from US tax and trade policies, macroeconomic policies in Canada should be tightened only gradually; the balance of risks warrants a gradual approach to monetary policy normalization.
- Fiscal policy:
  - No additional fiscal stimulus would be warranted.
  - The federal government should start rebuilding fiscal buffers now, at a gradual pace, as envisaged in the 2018 budget.
  - Ontario is on course for achieving an operating budget surplus in fiscal year 2017/18 but announced in its 2018 budget its intention to run a deficit of about ¾ percent of Ontario’s GDP over the next three fiscal years.
  - Quebec and British Columbia are expected to broadly maintain balanced operational budget positions, while Alberta is expected to step up its efforts to reduce deficits.
- Macroprudential and housing supply:
  - Authorities should hold off on additional macroprudential measures for now, until the effects of the recent measures are known.
  - More efforts may be warranted to address supply-side constraints in the housing market, including a review of zoning and density policies, the approval process for new developments, and the enhancement of urban transit systems.
- Structural reforms and other priorities:
  - Structural reforms are vital to boost competitiveness and growth over the medium term; agenda items include internal and external trade, innovation, immigration, and female labor participation.
  - As an immediate priority, a holistic review of the overall tax system would be critical to help assess the scope for improving the efficiency of the tax system, while maintaining Canada’s tax competitiveness, before a decision on a major tax reform.
  - Implementation of the long-term infrastructure investment plan has been delayed; further efforts are needed to make infrastructure investment more timely and efficient. Suggested steps include consolidating existing information on project plans from all levels of government and expanding the use of common standards of project evaluation.
  - The implementation of the Canadian Free Trade Agreement (which entered into force in July 2017) should be accelerated to reduce barriers to internal trade, investment, and labor mobility.
  - More can be done to reduce foreign direct investment restrictions and regulatory barriers to entry in key sectors of the economy.
  - Canada needs to continue diversifying its trade patterns. The Comprehensive Economic Trade Agreement with the European Union (entered into force in September 2017) is expected to boost trade with Europe, while a new Comprehensive and Progressive Agreement for Trans-Pacific Partnership would enhance ties with Asian economies.

### The US Tax Cuts and Jobs Act: key features and macroeconomic implications
- Corporate tax and international provisions:
  - Statutory corporate income tax rate lowered from 35 to 21 percent.
  - Temporary capital expensing: full deduction of certain capital investments until 2023, with a gradual phaseout to the previous depreciation system by 2027.
  - Interest deduction capped at 30 percent of EBITDA until 2022, and 30 percent of EBIT thereafter (unused deductions can be carried forward).
  - Pass-through entities: a 20 percent exemption on their incomes before the individual rates apply.
  - Move toward a territorial system with guardrails:
    - One-time repatriation tax: cash and cash equivalents taxed at 15.5 percent and other assets at 8 percent, payable over eight years.
    - Foreign-derived intangible income (FDII) effective tax rate of 13.125 percent (16.4 percent after 2025).
    - Global intangible low-taxed income (GILTI) effective tax rate of 10.5 percent (rising to 13.125 percent after 2025).
    - Base erosion anti-abuse tax: minimum 10 percent tax (12.5 percent after 2025) on certain deductible payments to foreign affiliates.
- Personal income tax changes:
  - Top marginal personal income tax rate reduced from 39.6 to 37 percent.
  - Standard deduction roughly doubled (from $13,000 to $24,000 for joint filers); individual exemptions and a range of itemized deductions eliminated.
  - Child tax credit increased from $1,000 to $2,000.
  - Alternative minimum tax scaled back (individuals affected reduced from 5 million to 200,000).
  - Estate tax exemption doubled to $11.2 million a person.
  - Carried interest preserved but limited to gains on assets held for at least three years.
  - All personal income tax measures sunset after 2025.
- Macroeconomic impacts and spillovers:
  - The corporate tax reform is expected to reduce distortions, increase attractiveness of investment in the United States, and reduce incentives to shift profits offshore.
  - The temporary capital expensing creates a timing distortion that will accelerate investments.
  - The US tax policy changes are expected to stimulate activity; the effect on US economic activity is estimated to be positive through 2020, cumulating to a level effect on real GDP of 1.2 percent through that year.
  - Direct international spillovers from the tax reforms are expected to be limited and contained to low-tax jurisdictions with large investments from US multinationals; demand spillovers from higher US growth and larger trade deficits are likely to be more important for closer trading partners, such as Canada and Mexico.
  - The changes contribute about half of the cumulative revision to global growth over 2018–19. Emerging markets with dollar-denominated debt could face the risk of a stronger US dollar.
  - The reduced corporate tax rate may place downward pressure on corporate tax rates in other jurisdictions and intensify tax competition; FDII may further intensify such pressure even as GILTI mitigates it in some respects.

*International Monetary Fund | April 2018*

### 1. LAC: External Demand and Real Exports Growth

### 1. LAC: External Demand and Real Exports Growth

### Growth outlook and short-term projections
- Regional projections for LAC (year labels implicit in source):
  - 2016: –0.6
  - 2017: 1.3
  - 2018: 2.0
  - 2019: 2.8
- Excluding Venezuela, average growth estimate for the region in 2017: 1.9 percent.
- Venezuela: the economy is estimated to have contracted by a further 14 percent in 2017.
- Private investment:
  - Private investment stopped being a major drag in 2017 after three consecutive years of contraction.
  - Private investment is expected to move solidly into positive territory in 2018–19 and to be the main driver of the projected economic acceleration in 2018 and 2019.
- Contributions to real GDP growth (regional): recovery in private consumption in 2017 followed by investment-led acceleration in 2018–19.

### External tailwinds, commodity terms of trade, and exports
- Commodity prices partly rebounded since early 2016; in some cases net commodity terms of trade have essentially reverted to their boom levels—especially in metal commodity exporters that are net oil importers (Chile, Peru).
- The likelihood that commodity terms of trade will return to—or stay above—their boom levels both in 2018 and over the medium term has increased for most countries in the region (stochastic simulations referenced).
- Current account dynamics:
  - Current account deficits in most countries narrowed over the past couple of years from recent peaks.
  - Most of the current account adjustment to date has been led by improvements in the private sector savings-investment balance, reflected in compression of imports attributable to income effects.
  - Mexico was a notable exception where the reduction in the current account deficit was led by improvements in public sector savings.
  - Going forward, current account deficits are expected to widen again as growth accelerates in domestic consumption and investment; the expansion in private sector investment is expected to offset the impact of fiscal consolidation on the current account.

### Domestic financial and macro indicators
- Credit and banking sector:
  - Private credit increased sharply during the commodity boom, with a doubling of the region’s credit-to-GDP ratio between 2005 and 2015, but has since broadly stabilized in several countries.
  - Nonperforming loans increased during the slowdown but are well provisioned and remain manageable in most countries.
  - Bank capital ratios remain strong and rates of return high; bank profits are largely driven by high interest margins amid high concentration and operating costs.
- Inflation and labor markets:
  - Consumer price inflation has come down sharply at the regional level.
  - Across most inflation-targeting countries in the region, inflation is back within the official target range.
  - In countries where inflation still exceeds the target, it is expected to moderate in 2018–19 as transitory supply-side factors recede.
  - Unemployment rates have already peaked in most countries; labor markets are showing signs of improvement.
- Financial market sensitivity:
  - The most financially integrated economies in the region—Brazil, Chile, Colombia, Mexico, and Peru—remain at risk for adverse developments in global financial markets.
  - Financial asset prices in these countries exhibit a high degree of synchronicity, and capital flows to the region are highly responsive to global shocks.
  - Recent bouts of market volatility highlight the vulnerability of countries reliant on large external financing, such as Argentina, to changes in foreign investor sentiment.

### Fiscal developments and public debt
- Following the end of the commodity super-cycle, fiscal revenues in most commodity-exporting countries fell noticeably relative to boom years.
- The loss in commodity revenue was particularly strong among hydrocarbon-exporting countries: Bolivia, Ecuador, Mexico, Trinidad and Tobago, Venezuela.
- Upward trend in current spending that began during the commodity price boom continued in several countries even after the bust, leading to deterioration in fiscal balances and debt ratios.
- Policy responses included raising noncommodity revenues (Argentina, Chile, Mexico, Trinidad and Tobago) or cuts in public investment.
- Longer-run fiscal indicators (qualitative): pressure on fiscal primary balances and public debt increases noted across many countries.

### Long-term prospects, structural constraints, and heterogeneity
- Over the longer term, growth prospects for the region remain weak; current potential growth estimates are similar to modest long-term averages.
- GDP per capita growth is substantially below that of most other emerging market regions and just slightly above advanced economies, hampering income convergence.
- Heterogeneity within the region is considerable; a few countries have lost significant ground in development prospects (notably Venezuela).
- Structural drags:
  - Relatively low investment levels and low productivity continue to dampen overall growth.
  - Misallocation of capital and labor resources appears to be an important element in the region’s long-term growth conundrum.

### Risks to the outlook
- Correction in global financial markets:
  - A sudden tightening of global financial market conditions—including higher-than-expected inflation pressures in the United States, faster-than-expected tightening of US monetary policy, and a rise in the term premium—could significantly affect long-term interest rates, capital flows, and financing conditions.
  - Spillovers from US interest rates can be significant for many countries (short-term: Mexico, Peru; long-term: Brazil, Colombia).
- Waning support for global economic integration and protectionism:
  - An increase in tariff and nontariff barriers could derail the upswing in world trade with serious effects on the region’s recovery.
  - Negotiations on NAFTA and proposals to impose import restrictions have contributed to uncertainty; Mexico, Central America, and the Caribbean remain particularly vulnerable to macroeconomic and policy developments in the United States.
- Political and domestic risks:
  - Elections, rising populist sentiment, and corruption scandals could materially affect economic prospects across the region.

*Source: Regional Economic Outlook: Western Hemisphere (April 2018), chapter "Outlook for Latin America and the Caribbean: The Right Policy Mix for Sustaining the Recovery."*

### 2. OUTLOOK fOR LATIN AMERICA ANd THE CARIbbEAN: THE RIGHT pOLICy MIx fOR sUsTAINING THE RECOvERy

### 2. OUTLOOK fOR LATIN AMERICA ANd THE CARIbbEAN: THE RIGHT pOLICy MIx fOR sUsTAINING THE RECOvERy

### Risks to the Regional Outlook
- Trade and remittance channels remain important transmission vectors; trade links with China are an important driver of external demand for South America.
- Accumulation of financial vulnerabilities in China from rising nonfinancial sector debt could spill over to the region through trade linkages and commodity prices.
- Noneconomic factors: geopolitical tensions and extreme weather events could adversely affect global financial markets, commodity prices, and external demand, with spillovers to the region; climate change and recurrence of extreme weather events and natural disasters are an important source of risk, most notably for the Caribbean (Box 2.3).
- Election cycle in Latin America in 2018 could generate economic and policy uncertainty; rising populism poses risks to implementation of reforms.
- Regional spillovers from Venezuela: sharp deterioration in social conditions has led to a humanitarian crisis and a sharp increase in emigration to Colombia, Brazil, and to a lesser extent Argentina, Chile, Ecuador, and Peru, putting pressure on social services in these countries. Other transmission channels less important; spillovers through trade and PetroCaribe agreements have already materialized. Investors view Venezuelan debt as a distressed asset, with no contagion to other emerging market assets.

### Policy Priorities (overview)
- In the context of an economic recovery gathering momentum, moderating inflation, and a widening set of risks, designing and implementing the right policy mix remain crucial.
- Where fiscal consolidation is warranted, efforts should be made to improve the quality of the adjustment.
- Monetary policy could be geared toward providing support to growth, provided inflation expectations remain well anchored.
- A comprehensive and well-designed set of structural policies fostering investment and private sector participation would boost potential growth in an inclusive and sustainable manner.

### Improving the Quality of the Fiscal Adjustment
- End of the commodity super-cycle caused a sharp fall in commodity revenues and a noticeable deterioration in fiscal balances; in some countries exacerbated by a slowdown in domestic demand and economic crises.
- Deterioration in debt dynamics, compounded by low expected commodity prices and reduced fiscal buffers, calls for appropriate fiscal adjustment.
- For several countries, required fiscal adjustment—in terms of changes in the primary fiscal balance to reach the debt-stabilizing level—is relatively small; however, for most countries primary balances are still noticeably below debt-stabilizing levels, most notably in Argentina, Bolivia, Brazil, and Trinidad and Tobago.
- Countries that experienced a larger increase in debt ratios following the end of the commodity super-cycle have more ambitious fiscal consolidation plans over the coming years (Figure 2.13).
- Some countries’ adjustment plans are front-loaded (Chile, Trinidad and Tobago), others are gradual and back-loaded (Brazil, Peru).
- Fiscal adjustment should aim at placing debt ratios on a sustainable path while tuning pace and composition to support and protect growth and productivity-enhancing spending.
- Analysis suggests fiscal consolidation episodes in the region have an impact on growth somewhat larger than previously thought (Chapter 4).
- Multipliers for public investment are larger than for public consumption; consolidation packages should aim to preserve public investment where possible.
- Where fiscal sustainability or credibility might be at risk, policymakers should consider front-loading the adjustment.
- Well-designed and transparent fiscal adjustment plans enhance policy credibility and investor confidence, conducive to more favorable funding conditions—particularly for countries that pay higher average spreads relative to other countries with comparable credit ratings (Figure 2.14)—and could engender stronger public support.
- Fiscal adjustment could be supplemented with broader fiscal reform; entitlement reform aimed at containing future fiscal pressures from demographic changes—particularly public pension and health expenditure—would improve long-term fiscal sustainability while having relatively small effects on short-term growth.

### Enhancing Monetary Policy Effectiveness While Supporting Growth
- Recent decline in inflation in several countries provided space for easing monetary policy; with inflation within (or close to) target bands and inflation expectations anchored, most inflation-targeting central banks have cut policy rates (Figure 2.15).
- Going forward, amid fiscal consolidation in large parts of the region, monetary policy could provide support to the ongoing economic recovery while keeping inflation expectations anchored.
- To enhance credibility and effectiveness, central banks should strengthen institutional and operational frameworks.
- More effective central bank communication and greater transparency—for instance, through press releases and by releasing minutes of monetary policy meetings—can improve policy predictability and traction (Chapter 3).
- Progress in inflation-targeting regimes is reflected in lower exchange rate pass-through into domestic inflation across several countries.
- Central banks remain challenged by exchange rate volatility and large depreciations; episodes of large currency depreciations have led to procyclical monetary policy stances even when inflation expectations remained well anchored (Figure 2.16).
- Maintaining a flexible exchange rate enhances resilience to external shocks, including sudden changes in global financial conditions, minimizing potential for disruptive capital flow reversals. The degree of exchange rate flexibility has varied across countries in the region, even among economies facing similar shocks (Figure 2.17).

### Subdued Growth Prospects and Structural Reform Priorities
- Strengthening cyclical recovery is welcome, but long-term prospects remain dim; boosting potential growth and productivity requires deep and comprehensive structural reforms.
- Policy fronts requiring sustained effort include education, health, business and regulatory environment, and gender equity and female participation, among others.
- Securing strong, durable, and inclusive growth requires addressing inequality; LAC remains the most unequal region in the world despite recent gains in poverty and inequality reduction.
- With a tighter fiscal envelope and poverty rates edging up, policies need to protect gains made in social areas (Chapter 5).
- Improving security and crime prevention is crucial where chronically high crime rates weigh heavily on growth (Box 2.4).

Policy priorities include:
- Human capital development through more efficient education spending to boost productivity and generate more inclusive and equitable growth. Educational attainment and learning outcomes remain low relative to other emerging market regions, even though the region spends more on education than other regions (Figure 2.18).
- Tackling infrastructure bottlenecks to boost investment levels; investment remains lower than in other emerging market regions, including sub-Saharan Africa (Figure 2.19).
- Improving governance and business climate, focusing on reducing corruption, which adversely affects confidence, private investment, and development. Corruption perceptions at the regional level are broadly in line with other emerging markets and the region’s level of development, but there are significant differences across countries even after accounting for per capita income (Figure 2.20).
- Pursuing trade and financial liberalization: trade openness levels in LAC are low compared to other regions, particularly in large economies such as Argentina and Brazil (Figure 2.21). Regional integration could promote openness and global integration. The Comprehensive and Progressive Agreement for a Trans-Pacific Partnership, signed in early March by 11 countries in the region, including Chile, Mexico, and Peru, would boost trade with Asia.

### South America: Developments and Outlook (selected country notes)
- Regional growth in South America resumed in 2017, averaging 0.7 percent (in purchasing-power-parity terms). Growth is expected to accelerate in both 2018 and 2019, dominated by recoveries in larger economies, notably Argentina and Brazil.
- Argentina:
  - Real GDP growth forecast: 2.0 percent in 2018 (current forecast below the January World Economic Outlook Update forecast), 3.2 percent in 2019.
  - Severe drought will negatively affect agricultural production and exports in 2018.
  - Primary fiscal deficit expected to decline in line with federal targets, mainly reflecting announced reduction of subsidies and consistency with the new Fiscal Responsibility Law at the provincial level.
  - Overall fiscal deficit will fall at a slower pace due to a larger interest bill.
  - Inflation expected to continue to fall but at a slower pace than targeted by the central bank, reflecting headwinds from further utility tariff increases and pickup of inflation expectations after the increase of inflation targets and easing of monetary policy in late 2017 and early 2018.
  - Continued reduction of the primary fiscal deficit through more front-loaded reduction in primary current spending would better anchor inflation expectations, reduce vulnerability from high gross fiscal financing needs, and put public debt ratio on a more sustainable path.
  - Stronger, sustainable, and more inclusive growth requires further progress in structural reforms to remove distortions and bottlenecks.
- Bolivia:
  - Real GDP grew by 4.2 percent in 2017.
  - Real GDP projected to grow by 4 percent in 2018.
  - Since the 2014 terms-of-trade shock, government pursued expansionary fiscal and monetary policies financed by drawdown of savings and increased borrowing.
  - Sizable fiscal and current account deficits that emerged in 2014 are expected to persist absent material policy change, albeit at lower levels.

*International Monetary Fund | April 2018*

### 2. Distribution within Latin America and the Caribbean

### 2. Distribution within Latin America and the Caribbean

### Regional patterns and indicators
- Trade openness and investment patterns are compared across regions using purchasing-power-parity GDP-weighted averages and ISO country codes for labels (figures referenced). Regional groupings: ADV = advanced economies; Asia = emerging and developing Asia; CIS = Commonwealth of Independent States; EME = emerging and developing Europe; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; SSA = sub-Saharan Africa.
- Advanced economies = 124.9 (trade openness reference in figure).

### Country-level developments and outlook (selected countries)
- Brazil
  - Real GDP is expected to grow at 2.3 percent in 2018.
  - Inflation expected to accelerate gradually from 3 percent toward the midpoint of the inflation target in 2019.
  - Fiscal consolidation continued in 2017; current budget implies an expansionary fiscal stance in 2018 and fiscal consolidation starting in 2019, with yearly reductions in federal government expenditure of 0.5 percent of GDP over the next 10 years.
  - Social security reform has been postponed; reforming other mandatory outlays, including the wage bill, is important.
  - Key risks: policy agenda changes following the October presidential election could raise market volatility and uncertainty about the medium-term outlook.

- Chile
  - Growth for 2018 has been revised up to 3.4 percent (2017: 1.5 percent).
  - Monetary policy described as appropriately accommodative; central bank should wait until inflation shows clear convergence toward its target and growth momentum becomes self-sustaining before normalizing policy.
  - Fiscal policy should stay on a gradual consolidation course while balancing social and development objectives.

- Colombia
  - Growth lifted to 2.7 percent in 2018 due to policy easing and favorable global environment.
  - Mildly expansionary fiscal policy and lagged effects of monetary easing in 2017 will support domestic demand.
  - Investment projected to increase strongly on infrastructure projects (Fourth Generation Program), oil sector projects, and the 2016 tax reform.

- Ecuador
  - Recovery supported by partial rebound in oil prices, favorable external financial conditions, and continued public sector spending.
  - Vulnerabilities: weak fiscal position, real effective exchange rate overvaluation, low foreign reserves; susceptible to tighter financing, fall in oil prices, or US dollar appreciation.
  - Recommendation: clear, front-loaded, balanced, and well-communicated fiscal reform; structural reforms to address competitiveness problems.

- Paraguay
  - Economy expected to expand by 4½ percent in 2018, led by strong domestic demand.
  - Bank credit recovering; monetary policy was eased in August 2017.
  - With strengthening domestic demand and resuming credit growth, inflationary pressures have begun to rise—need to gradually remove monetary accommodation.
  - Fiscal anchor operating well, but additional restraint on growth of current primary spending relative to budget plans will be needed in 2018.

- Peru
  - Economy grew at 2.5 percent in 2017.
  - Central bank reduced policy rate six times since May 2017 and lowered reserve requirements.
  - Government increased 2017–19 deficit targets for reconstruction/rehabilitation projects, with consolidation planned thereafter to bring the deficit in line with the fiscal rule.
  - Policies expected to help economic growth rebound to around 3¾ percent in 2018.
  - Downside risks associated with the Odebrecht investigation persist.

- Uruguay
  - Growth expected to exceed 3 percent in 2018.
  - Tight monetary policy and appreciating exchange rate contributed to a notable decline in inflation, bringing it within the central bank’s target range (3 to 7 percent) in 2017 for the first time in seven years.
  - Some monetary tightening would be appropriate; fiscal deficit in 2017 slightly larger than projected—case for saving growth-related revenue windfalls in 2018 to safeguard the 2019 fiscal deficit target of 2.5 percent of GDP.
  - Recommendation: reorient budget spending from public wage bill toward investment given infrastructure gaps.

- Venezuela
  - Economy is expected to contract by 15 percent in 2018, following a cumulative 35 percent contraction over 2014–17.
  - Consumer price inflation estimated at about 2,800 percent in 2017 and projected to rise to about 13,000 percent in 2018.
  - International reserves dropped to about $9.3 billion by the end of January 2018; liquid net international reserves appear to be exhausted.
  - Bonds for the Republic and for PDVSA are in selected default since the last quarter of 2017.
  - Government unified and depreciated the official exchange rate in early February 2018, but underlying imbalances remain unaddressed.

- Mexico
  - Output growth is expected to accelerate from 2 percent in 2017 to 2.3 percent in 2018, supported by net exports and remittances.
  - Inflation projected to continue falling in 2018 and converge toward the central bank’s 3 percent target around the middle of 2019.
  - Downside risks include a disorderly NAFTA breakup; successful renegotiation would boost trade, output, and employment.

- Central America, Panama, and the Dominican Republic (CAPDR)
  - Growth remained robust at about 4 percent in 2017, supported by solid domestic demand and the upswing in global trade.
  - Remittances are a critical external flow—now the most important external flow to the region, dwarfing foreign direct investment and official aid.
  - Current account deficits declined in 2017 for some countries despite rising oil bills; reserve buffers strengthened in Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua.
  - Inflation accelerated in 2017 in most countries but remains within target ranges in inflation-targeting frameworks.
  - After three years of deficit reductions, fiscal deficits widened in 2017 across the region; average public-debt-to-GDP ratio in CAPDR continued to increase.
  - Risks: tighter US immigration policy could reduce remittances; tighter global financial conditions could raise external financing costs (Costa Rica, Dominican Republic, El Salvador); political dissonance (El Salvador, Honduras).

### Policy priorities and recommendations
- South America (general)
  - Aim to place the debt-ratio path on a sustainable footing while minimizing adverse impacts on short- and medium-term growth.
  - Use higher commodity revenues to adjust the pace and composition of fiscal adjustment and to push through fiscal reforms (including pension reform).
  - Monetary policy should support recovery and may provide accommodation to accompany fiscal adjustment, provided inflation convergence toward the target band and inflation expectations remain anchored.
  - Exchange rate flexibility should remain the first line of defense against external shocks.

- Brazil-specific
  - Front-load fiscal adjustment while implementing structural reforms: improve credit allocation, open up the economy, boost infrastructure quality, simplify the tax system, reduce red tape.
  - Implement social security reform and reform other mandatory outlays to meet the constitutional expenditure rule.

- Chile-specific
  - Maintain gradual fiscal consolidation; delay monetary normalization until inflation convergence is evident.

- Ecuador-specific
  - Implement clear, front-loaded, balanced, and well-communicated fiscal reform; pursue structural reforms to address competitiveness.

- Paraguay-specific
  - Gradually remove monetary accommodation as inflation pressures rise; restrain growth of current primary spending in 2018.

- Peru-specific
  - Continue structural reforms to improve tax system efficiency, expand economic and financial inclusion, and close the infrastructure gap.

- Uruguay-specific
  - Save possible growth-related revenue windfalls in 2018 to safeguard the 2019 fiscal deficit target of 2.5 percent of GDP; reorient spending toward investment.

- Venezuela-specific
  - No new policy prescriptions detailed beyond noting that exchange-rate unification and depreciation do not address severe underlying imbalances.

- Mexico and CAPDR
  - Mexico: preserve macroeconomic stability; continue prudent fiscal policy to reduce public-debt-to-GDP ratio and strengthen fiscal responsibility framework; improve public expenditure efficiency and tax collection; conditional on anchored inflation expectations, scope to ease monetary policy once inflation is on a downward path; continue structural reforms including anti-corruption measures.
  - CAPDR: fiscal consolidation needed in most countries to rebuild buffers; support consolidation through revenue mobilization (Costa Rica, Dominican Republic, El Salvador, Nicaragua, Panama) and current spending containment (Costa Rica, El Salvador, Honduras).
    - In Nicaragua, pension reform is needed to address an imminent cash balance constraint and secure long-term viability.
    - Revenue mobilization via broadening tax bases (streamlining tax exemptions), strengthening tax administration, and in some cases aligning tax rates with regional averages.
    - Calibrate consolidation to avoid sharp growth drags and protect the most vulnerable by improving efficiency and quality of education and health spending and increasing targeted social spending.
    - In Guatemala, scope exists for more expansionary fiscal policy to increase social, security, and infrastructure spending.
    - Strengthen fiscal policy frameworks with credible medium-term fiscal anchors.
  - In countries with flexible exchange rates, maintain exchange rate flexibility and transparency around interventions; improve central bank communication and monetary policy frameworks to strengthen credibility of inflation-targeting regimes.

*Source: Regional Economic Outlook: Western Hemisphere, International Monetary Fund | April 2018 (chapter: 2. Distribution within Latin America and the Caribbean).*

### 1. CAPDR: Real GDP Growth

### 1. CAPDR: Real GDP Growth

### Regional financial sector and macrofinancial vulnerabilities
- The financial sector "appears sound," with progress in anti–money laundering/combating the financing of terrorism (AML/CFT) compliance through legislative measures and stronger implementation, supporting access to correspondent banking relationships.
- Recommendations to strengthen financial stability and manage macro-financial risks:
  - Integrate systemic risk into supervisory and regulatory frameworks, including development of macroprudential policy frameworks.
  - Continue transition toward Basel III.
  - Strengthen consolidated and risk-based supervision through enhanced supervisory cooperation and cross-border coordination.
  - Build on progress by continuing to strengthen tax transparency and financial integrity.
- Specific macrofinancial concern: foreign-exchange-related risks in a highly dollarized region (Costa Rica, Dominican Republic, Honduras, Nicaragua).

### Governance, security, and structural reforms
- Tackling corruption and improving law enforcement and security (highlighted for El Salvador, Guatemala, Honduras) is imperative to attract foreign direct investment and durably increase investment and potential growth.
- Broader need for structural reforms to raise productivity and potential growth.

### Caribbean — developments and outlook
- Prospects generally improving; "growth in both tourism-dependent economies and commodity exporters projected in the 1–2 percent range for 2018 and 2019."
- Tourism developments:
  - Several countries registered strong tourism growth in 2017, including Barbados, Belize, Jamaica, and St. Lucia, supported by increased arrivals in stopover and cruise segments.
  - Continued support expected in 2018 from higher US growth (major source market), with some exceptions (e.g., Barbados heavily dependent on the United Kingdom).
- Severe hurricane impacts and recovery:
  - Some islands hit hard in the 2017 hurricane season face protracted recovery.
  - Dominica: "GDP is projected to decline by 16.3 percent in 2018, before rebounding in 2019 as reconstruction gathers pace."
- Commodity exporters:
  - Trinidad and Tobago and Suriname experienced recessions (Trinidad and Tobago 2015–17; Suriname 2015–16) due to low commodity prices; modest return to growth expected in 2018 and 2019 as commodity prices improve.
  - Guyana: stronger growth supported by two new large gold mines and positive sentiment ahead of beginning oil production in 2020.
- Downside risks for the Caribbean:
  - Natural disasters and climate change (Box 2.3).
  - Potential further loss of correspondent banking relationships.
  - Risks associated with citizenship-by-investment programs (Box 2.5).

### Caribbean — policy priorities
- Public sector debt remains a major vulnerability.
  - In some tourism-dependent economies, debt ratios are retreating from very high levels via multiyear fiscal consolidation (examples: Grenada, Jamaica, St. Kitts and Nevis).
  - Continued fiscal prudence needed to gradually reduce debt-to-GDP ratios and build buffers against shocks.
  - Other countries (Antigua and Barbuda, Barbados, Belize) need to tighten fiscal stance combined with structural reforms to bolster growth and reduce public debt.
  - A well-designed fiscal rule can help guide consolidation and broaden support.
- Commodity-exporting countries (Trinidad and Tobago, Suriname):
  - The 2014–15 commodity price decline led to large fiscal deficits and rapid public debt increases.
  - Need tighter fiscal policies within medium-term macroeconomic adjustment to reestablish sustainable fiscal paths and ensure debt sustainability.
- Financial sector resilience:
  - Numerous banks continue to have high levels of nonperforming loans, constraining credit and increasing vulnerability.
  - Eastern Caribbean Currency Union progress: regulatory enforcement of capital requirements and balance-sheet cleanup.
  - Further reforms needed: strengthen oversight of nonbank financial institutions; enhance capital adequacy of indigenous banks.
  - Securing correspondent banking relationships through effective AML/CFT implementation, bank consolidation, and improved communication with correspondent banks is an additional priority.
- Structural reform priorities to enhance competitiveness, private investment, and growth:
  - Reduce high electricity costs via energy conservation and diversification of the energy mix.
  - Deepen financial systems and enhance access to credit.
  - Tackle violent crime.
  - Reduce high unemployment and brain drain by improving the business climate and strengthening institutions.
  - Sector-specific policies to support structural transformation and tourism (advertising, training, nature conservation, transportation infrastructure).

### Market views, cyclical rebound, and risks (Box 2.1)
- Market sentiment in March: upbeat about near-term growth momentum but worried about medium-term prospects and potential policy complacency on reforms.
- External risks highlighted by markets:
  - Exposures to external risks for economies with high dollar financing needs.
  - Risk from sharper-than-expected US Federal Reserve tightening (stronger dollar and higher dollar interest rates).
  - Uncertainty about NAFTA outcomes and spillovers from US tax reform.
- Domestic risks: political risks tied to upcoming national elections and the crisis in Venezuela; concerns about anti-establishment or populist candidates reversing reforms.

### Long-term growth and resource allocation (Box 2.2)
- Long-term growth in Latin America and the Caribbean projected at 1.8 percent in per capita terms.
- Low productivity is a drag on overall growth; misallocation of capital and labor is an important contributor.
- Spread of revenue productivity across firms (ratio of 75th percentile to 25th percentile of relative TFPR; data apply to 2015):
  - United Kingdom: 6.8
  - Mexico: 11.3
  - Brazil: 12.4
  - Colombia: 15.7
- Estimated gains in manufacturing total factor productivity (TFP) from equalizing revenue productivity across firms within each sector:
  - Brazil: 51
  - Colombia: 61
  - Mexico: 48
- Potential drivers of misallocation and policy implications:
  - Tax incentives for small enterprises that allow unproductive small firms to survive can impede productive firm creation and scale economies.
  - Tax treatment differences (example: Brazil) can reduce allocative efficiency by biasing investment incentives.
  - State subsidies to favored firms can create size distortions and persistent market power.
  - Regulatory inflexibility and barriers to entry can impede innovative firm entry and resource reallocation.
  - Access to financial services reduces misallocation (evidence from Mexico).
  - Informality associated with higher allocative inefficiency; policies reducing informality can improve resource allocation and productivity.
- Calculations follow Hsieh and Klenow (2009) methodology; estimates indicative and may be upper bounds.

### Natural disasters, disaster financing, and IMF support (Box 2.3)
- The Caribbean is highly vulnerable to natural disasters; recent examples: Hurricane Matthew (2016), Hurricanes Irma and Maria (2017).
- Preliminary rapid damage and loss assessment: Dominica recovery costs estimated at "more than 200 percent of GDP."
- IMF response and tools:
  - IMF has provided assistance through the Rapid Credit Facility (RCF) and Rapid Financing Instrument (RFI) in recent years.
  - In May 2017 the IMF increased annual access limits under the RCF and RFI to "60 percent of quota" for countries experiencing large natural disasters (exceeding 20 percent of GDP in damages).
  - The interest rate on RCF loans is "0 percent."
- Disaster risk management and financing instruments:
  - Build disaster and climate-change risks into budgets, fiscal rules, and public investment plans; establish fiscal buffers or contingency funds sized by disaster risk assessments.
  - Use insurance and financial hedging tools; regional coordination to pool insurance coverage at the Caribbean level.
  - The Caribbean Catastrophe Risk Insurance Facility (CCRIF):
    - Provides parametric insurance with quick settlement (usually within 14 days) based on predetermined triggers.
    - Paid out "$55 million" following Hurricanes Irma and Maria in 2017.
    - Allows lower-cost insurance at the regional level but countries remain underinsured because premiums are still high.
  - State-contingent clauses in sovereign debt (example: Grenada's 2015 debt restructuring) can help manage cash flow and smooth consumption and investment after disasters.

*International Monetary Fund | April 2018 — Regional Economic Outlook: Western Hemisphere*

### Box 2.3. Resilience to Natural Disasters and Climate Change

### Box 2.3. Resilience to Natural Disasters and Climate Change

### Crime prevalence and measurement
- Homicide rates in CAPDR and the Caribbean are among the highest in the world; El Salvador and Jamaica have the top two rates worldwide.
- Honduras peaked at a homicide rate of 87 per 100,000 people in 2011 and saw this rate halve to 43 per 100,000 people by 2017.
- Belize, St. Kitts and Nevis, and Guatemala rank fourth to sixth, remaining significantly above averages for the rest of Latin America and the world.
- Conviction rates for homicides over 2007–15 in both CAPDR and the Caribbean averaged only about 20 percent (versus 40 percent globally).
- Victimization surveys find that over a quarter of the population in CAPDR and the Caribbean cites crime as the biggest problem, compared with the Latin America and Caribbean average of 11 percent.
- Incidence of victimization tends to be higher for men, youth, and those with lower levels of education.
- Measurement caveats:
  - Definitions of crime differ across countries.
  - Nonfatal crime is often underreported.
  - Reverse causation between low growth and crime complicates isolating crime’s effect on economic growth.

### Identification strategy and auxiliary facts
- To address reverse causality, criminal deportations from the United States are used to capture the causal effect of homicides on growth, since deportations likely affect crime in home countries but are not large enough to impinge on growth directly.
- For the top four countries, the cumulative number of deportees from 1998–2014 was only about 2.5 percent, 2.4 percent, 1.5 percent, and 1.4 percent of the labor force for El Salvador, Honduras, Jamaica, and Guatemala, respectively.
- Probit results using victimization surveys suggest that being a victim of a crime can increase a person’s probability of wanting to emigrate by as much as 10 percentage points.
- Firm-level data from Colombia show that lowering victimization rates improves both investment and employment outcomes.

### Quantified impacts on growth and welfare
- Results suggest that if CAPDR and Caribbean countries were to reduce their crime rates to the world average, GDP growth could be higher by around 0.4 percentage point a year in El Salvador, Jamaica, and Honduras.
- Cumulative GDP losses due to high crime rates during 1999–2015:
  - El Salvador: about 9½ percentage points of GDP.
  - Honduras: about 7½ percentage points of GDP.
  - Jamaica: about 7 percentage points of GDP.
- Channels through which crime reduces growth include:
  1. Cost of goods lost.
  2. Public and private costs for prevention, deterrence, and imprisonment.
  3. Lost productivity from the prison population and victims.
- According to IDB (2017), these costs can add up to about 4 to 5 percent of GDP a year for CAPDR and the Caribbean countries, although private versus public spending ratios are diverging.
- Nonmonetary effects:
  - Criminal activity and shorter life spans discourage investment in human and physical capital and erode job creation.
  - Crime fosters brain drain, which is especially pertinent for the Caribbean where growth has been chronically low.
  - Crime can generate a cycle of negative labor market outcomes for youth, further fostering criminality and lowering growth.

### Policy implications and recommendations
- Tackling crime requires a combination of:
  1. Implementing policies to spur growth and promote economic opportunities.
  2. Improving deterrence and crime prevention.
  3. Strengthening the criminal justice system.
- Given fiscal constraints, interventions should be targeted and evidence based:
  - Focus on interventions directed towards at-risk youth.
  - Invest in data collection and monitoring.
- Security budgets should go beyond deterrence to include:
  - Skill development.
  - Vocational and social programs for youth.
- Strengthen credibility and efficiency of the criminal justice system to enable swift judgments.
- Provide basic skills training to convicts to bolster reintegration into the productive sector.
- Reduce prison overcrowding and improve prison quality to help prevent criminal activity within prisons.

*Box prepared by Uma Ramakrishnan and Joyce Wong; supporting analysis and references as presented in the source.*

### 2. OUTLOOK fOR LATIN AMERICA ANd THE CARIbbEAN: THE RIGHT pOLICy MIx fOR sUsTAINING THE RECOvERy

### 2. OUTLOOK fOR LATIN AMERICA ANd THE CARIbbEAN: THE RIGHT pOLICy MIx fOR sUsTAINING THE RECOvERy

### Regional outlook: key economic and social indicators (selected)
- Latin America and the Caribbean (2017, latest available):
  - GDP (Billions of US dollars): 5,492.9
  - Population (Million): 619.8
  - GDP per Capita (PPP US dollars): 15,785
  - Nominal Output Share of LAC Region (Percent): 100.0
  - Real GDP Growth (Percent): 2.1
  - CPI Inflation (Percent): 4.9
  - Current Account (Percent of GDP): 2
  - Domestic Saving (Percent of GDP): 19.3
  - Trade Openness (Percent of GDP): 42.5
  - Gross Reserves (Percent of GDP): 15.7
  - Unemployment Rate (Percent): 12.8
  - Gini Coefficient: 49.5

- Selected country snapshots (2017, latest available):
  - United States: GDP 19,390.6; Population 325.9; GDP per Capita (PPP) 59,501; Real GDP Growth 1.4; CPI Inflation 1.6.
  - Mexico: GDP 1,149.2; Population 123.5; GDP per Capita (PPP) 19,903; Real GDP Growth 2.1; CPI Inflation 4.2.
  - Brazil: GDP 2,055.0; Population 207.7; GDP per Capita (PPP) 15,603; Real GDP Growth 1.6; CPI Inflation 6.1.
  - Argentina: GDP 637.7; Population 44.1; GDP per Capita (PPP) 20,876; Real GDP Growth 1.7.
  - Peru: GDP 215.2; Population 31.8; GDP per Capita (PPP) 13,334; Real GDP Growth 4.9.
  - Venezuela: GDP 210.1; Population 31.4; CPI Inflation 353.4; Current Account 1.7; Sovereign Credit Rating: SD.

- Caribbean and small states (selected):
  - The Bahamas: GDP 11.6; Population 0.4; GDP per Capita (PPP) 31,139; Real GDP Growth 0.2.
  - Trinidad and Tobago: GDP 21.6; Population 1.4; GDP per Capita (PPP) 31,367; Real GDP Growth 0.4; CPI Inflation 0.3.
  - Eastern Caribbean Currency Union (aggregate): GDP 11; Population 6.6; GDP per Capita (PPP) 18,341; Real GDP Growth 1.0.

### Fiscal position: regional fiscal aggregates (Annex Table 2.2, Western Hemisphere)
- Latin America and the Caribbean — Public sector indicators (Percent of GDP)
  - Public Sector Primary Expenditure: 2015: 28.9; 2016: 28.7; 2017: 28.2; 2018 (Est.): 27.7; 2019 (Projections): 27.1
  - Public Sector Primary Balance: 2015: 22.7; 2016: 22.6; 2017: 22.1; 2018 (Est.): 21.7; 2019 (Projections): 21.3
  - Public Sector Gross Debt: 2015: 54.5; 2016: 57.8; 2017: 60.5; 2018 (Est.): 64.7; 2019 (Projections): 65.7

- Regional subgroup fiscal averages (selected)
  - South America — Public Sector Primary Expenditure: 2015: 31.3; 2016: 30.4; 2017: 30.8; 2018 (Est.): 30.4; 2019 (Projections): 29.5
  - CAPDR (Central America and the Dominican Republic) — Public Sector Primary Expenditure: 2015: 18.6; 2016: 18.8; 2017: 19.1; 2018 (Est.): 18.9; 2019 (Projections): 19.0
  - Caribbean — Public Sector Primary Expenditure: 2015: 24.5; 2016: 25.1; 2017: 25.5; 2018 (Est.): 25.1; 2019 (Projections): 24.6
  - Commodity exporters (small-country sample) — Public Sector Gross Debt: 2015: 50.5; 2016: 65.0; 2017: 65.8; 2018 (Est.): 65.4; 2019 (Projections): 66.0

### Monetary policy, exchange-rate shocks, and central bank credibility — analysis and findings
- Context and experience:
  - Following a series of terms-of-trade and other supply shocks, currencies of the LA5 (Brazil, Chile, Colombia, Mexico, and Peru) "were subject to some of the largest depreciations in decades."
  - These depreciations "led to inflation rising above central bank targets amid weaker economic activity and wider output gaps."
  - However, "the rise in inflation was less than experienced in previous episodes," reflecting strengthened monetary policy frameworks over the past two decades that "helped contain the exchange rate pass-through to consumer prices."

- Central bank credibility and policy trade-offs:
  - Central bank credibility—measured by the degree of anchoring in inflation expectations—plays a critical role in policy responses to large external shocks.
  - Stronger transparency frameworks and communication strategies are associated with:
    - more predictable policy decisions;
    - better anchoring of inflation expectations;
    - greater room to maneuver interest rate policy in the face of transitory inflation shocks.
  - Authorities faced evident tensions and trade-offs: whether to
    - increase policy rates to stop persistently high inflationary pressures and prevent inflation expectations from becoming unanchored; or
    - lower policy rates to offset negative income effects resulting from reduced purchasing power associated with weaker terms of trade.

- Policy-relevant mechanisms:
  - Enhanced transparency and clear communication can strengthen central bank credibility.
  - Better-anchored inflation expectations reduce the need for large policy-rate hikes in response to exchange-rate-driven inflation, allowing a more balanced policy mix amid output gaps and income shocks.

### Implications for policy prescriptions (derived from chapter analysis)
- Strengthen transparency frameworks and communications to:
  - improve predictability of monetary policy actions;
  - better anchor inflation expectations;
  - provide central banks with more flexibility when confronting transitory inflation shocks.
- Recognize and manage policy trade-offs explicitly:
  - balance the objective of preventing unanchored inflation expectations with the goal of cushioning negative income effects from exchange-rate-driven terms-of-trade shocks.
- Leverage robust inflation-targeting frameworks:
  - continued strengthening of frameworks can mitigate exchange rate pass-through and limit inflation overshoots during large depreciations.

*International Monetary Fund | April 2018 — 2. OUTLOOK fOR LATIN AMERICA ANd THE CARIbbEAN: THE RIGHT pOLICy MIx fOR sUsTAINING THE RECOvERy*

### Chapter 2 of the April 2016 Regional Economic

### 3. Credibility, Communication, and Monetary Policy Procyclicality in Latin America

### Procyclicality of Monetary Policy and Inflation-Targeting Frameworks
- LA5 central banks, with the notable exception of Chile, increased policy interest rates during the period of weak growth described in the chapter.
- Raising rates when growth is weak amounted to some degree of procyclicality in the monetary policy response.
- Several factors contributed to monetary policy procyclicality, including central bank credibility (degree of anchoring in inflation expectations), degree of financial dollarization, central bank independence, governance and institutional quality, and delays in fiscal consolidation amid widening external imbalances.
- Among the LA5 economies, except for Chile, survey-based medium-term inflation expectations remained above the midpoint of central bank targets for a prolonged period.
- Even starting with well-anchored expectations does not ensure they remain anchored once inflation is outside the central bank’s target range for an extended period.
- Effective communication by central banks that provides clear public guidance about the conditional future direction of monetary policy and the balance of risks to inflation reaching the target within the policy horizon is instrumental to implementing a sustained countercyclical policy response.

### Empirical Evidence: Credibility and the Cyclicality of Monetary Policy
- Sample and shock:
  - Analysis covers a sample of 20 inflation-targeting economies responding to protracted terms-of-trade shocks.
  - The illustrative shock modeled is a 20 percent decline in the terms of trade.
- Key empirical findings from an IPVAR framework:
  - The response of gaps in medium-term inflation expectations (absolute difference between expectations and target) is estimated over four quarters following the 20 percent terms-of-trade decline.
  - Economies with less-anchored expectations (initial gap above the 75th percentile) saw a widening of the expectation gap of 30 basis points following the terms-of-trade shock.
  - Economies with the most credible central banks (inflation gaps below the 50th percentile) saw no significant widening of inflation expectation gaps following the same shock.
  - Where deterioration of inflation expectations is greater, this is accompanied by a more aggressive increase in policy rates.
  - Economies with better initial anchoring of inflation expectations lowered their policy rates despite higher observed inflation.
  - The higher degree of procyclicality in countries with lower central bank credibility exacerbated the effect of the terms-of-trade shock on economic activity (domestic demand).

### Transparency and Credibility
- Transparency framework elements considered essential:
  1. A formal policy objective such as price stability (including explicit quantification).
  2. An assessment of the current state of the economy.
  3. An explanation of policy decisions.
  4. A forward-looking analysis.
  5. Publication of the economic data and forecasts used in the central bank’s assessment.
- Characteristics of LA5 transparency practices:
  - Policy rate decisions are accompanied by press releases explaining decisions and providing an assessment of the balance of risks for inflation.
  - Baseline scenarios and balance of risks are delineated in quarterly monetary policy reports.
  - Central banks release data used for decisions (output gaps, inflation, inflation expectations, wages, employment, and GDP).
  - All LA5 central banks, except the Central Reserve Bank of Peru, release minutes of policy meetings before the subsequent meeting; names are not assigned to transcribed comments, and votes are attributed only in the case of Chile and Brazil.
  - Governors are summoned to periodic parliamentary hearings in Brazil, Chile, Colombia, Mexico; some central banks publish transcripts of monetary policy decision meetings with a long lag (Chile).
  - Deficiencies arise from gaps in operational transparency (lack of assessments of forecasting and operational performance).
- Empirical link between transparency and credibility:
  - Using the Dincer and Eichengreen (2014) central bank transparency index (index ranges from 1 to 15, with 15 being the most transparent), conditional IPVAR results show:
    - Lower transparency is associated with inflation expectation gaps that widen significantly in response to inflationary shocks.
    - Gains from increasing central bank transparency display diminishing returns; the largest benefits accrue mainly at low levels of transparency.
    - Many Latin American central banks, characterized by lower levels of transparency, stand to benefit from expanding transparency frameworks.
  - Transparency is associated with lower monetary policy procyclicality:
    - Central banks with the current average transparency score of LA5 central banks increased the policy rate by 50 basis points for each 100 basis point increase in inflation following the decline in the terms of trade.
    - In contrast, a country with Australia’s current level of transparency kept the policy rate unchanged after the same shock.
  - Increased monetary tightening in less-transparent economies increases macroeconomic volatility because inflation and output move in opposite directions after a terms-of-trade decline.

### Communication: Quality over Quantity
- Effective communication should strengthen the signal-to-noise ratio; it is not the quantity but the quality of information that matters.
- An effective communication strategy makes policy more predictable and market expectations about future short-term rates more accurate.
- Short-term central bank predictability is measured by survey forecast errors: the difference between analysts’ expectations gathered the day before each monetary policy decision and the actual decision outcome.
- The chapter analyzes the structure and content of press releases and minutes of monetary policy meetings to assess the quality of central bank communications and their effect on predictability and credibility over the past eight years, a period of large terms-of-trade and other supply-side shocks.

### Policy Implications and Recommendations
- Strengthen central bank credibility to reduce monetary policy procyclicality; credibility helps avoid aggressive tightening in response to transitory shocks.
- Expand and improve transparency frameworks, prioritizing the quality of communication:
  - Provide clear public guidance on conditional future policy direction and the balance of risks to inflation reaching the target within the policy horizon.
  - Improve operational transparency by publishing assessments of forecasting and operational performance.
  - Ensure credible, forward-looking communication that anchors medium-term inflation expectations.
- Focus reforms where they yield the largest marginal gains: increases in transparency from low levels produce the greatest benefits for anchoring expectations and reducing procyclicality.

*Source: Chapter 2 (3. Credibility, Communication, and Monetary Policy Procyclicality in Latin America), Regional Economic Outlook: Western Hemisphere, April 2018.*

### 3. CREdIbILITy, COMMUNICATION,  ANd MONETARy pOLICy pROCyCLICALITy IN LATIN AMERICA

### 3. CREdIbILITy, COMMUNICATION,  ANd MONETARy pOLICy pROCyCLICALITy IN LATIN AMERICA

### Monetary policy predictability and surprises
- Short-term predictability of interest rate decisions is low in Latin America, with the notable exception of Chile.
- Forecast errors for Colombia and Brazil are the largest in a sample of 18 inflation-targeting economies.
- Monetary policy surprises are also most frequent in Latin America. Since 2010, the Central Bank of Colombia “surprised” markets once every five meetings.
- The frequency of monetary policy surprises has increased in recent years for all LA5 central banks except Brazil, despite previous inflationary shocks having mostly dissipated.
- Empirical indicator reported: R^2 = 0.38 (figure caption).

### Communication: length, readability, and their correlations with predictability
- Text length trends (press releases accompanying policy decisions, average word count):
  - Mexico and Brazil exhibit big increases in recent years in the average word count of press releases.
  - Longer press releases in Brazil and Mexico resulted from pushes to improve policy transparency.
- Readability measures:
  - Flesch reading ease (RE) index used for Brazil (English); Flesch-Szigriszt index used for Spanish documents (Chile, Colombia, Mexico, Peru).
  - Flesch RE formula (English): RE = 206.835 – (1.015 x ASL) – (84.6 x ASW), where ASL = average sentence length, ASW = average number of syllables per word.
  - Flesch-Szigriszt formula (Spanish): RE = 206.835 – (ASL) – (84.6 x ASW).
- Readability results and implications:
  - Improvement in the clarity of communication has taken place in Chile, and to a lesser extent in Colombia.
  - Press statements in Chile, Colombia, and Peru use the same language complexity as the business section of local newspapers, while press statements from Brazil and Mexico use more complicated language.
  - Longer central bank statements tend to be more difficult to read; quantity does not equal quality.
  - More readable press statements are associated with lower monetary policy forecast errors.

### Forward guidance, tone, and market effects
- Frequency of explicit policy guidance in press releases, 2011–17:
  - Latin American central banks used explicit policy guidance infrequently, with the notable exception of the Central Bank of Chile.
  - Chile included a policy “bias” at a rate of once every two meetings.
- Impact of guidance on transmission:
  - Announcements containing an explicit policy “bias” are associated with higher transmission from policy rates to inflation expectations.
  - Effect of unanticipated increase in policy rate on breakeven inflation (one-day change in difference between yield on 10-year nominal and inflation-linked government bonds) shows larger effects when guidance accompanies policy changes (figure referenced).
- Tone indices and predictive power:
  - Computational linguistic measures classify policy discussion tone in minutes and press releases as “hawkish” or “dovish.”
  - LA5 central banks tend to back up words with deeds: more “hawkish” tones tend to result in tightening of the policy rate in subsequent meetings; more “dovish” tones tend to result in loosening.
  - Tone in central bank documents in Colombia and Mexico are reliable predictors of future policy changes.
- Market sensitivity to communication:
  - Tone of press releases and minutes affects short-, medium-, and long-term interest rates.
  - In Chile, the tone in press releases explains a significant share of variation in market rates (particularly short-term rates), while the tone in minutes has a negligible effect due to minutes being closely aligned with statements and published with a lag.
  - Market sensitivity to tone in minutes is more apparent in Brazil and Mexico, and to a lesser extent in Colombia.

### Policy takeaways and recommendations
- Credibility measure: the absolute difference between medium-term inflation expectations and the midpoint of central bank targets matters for policy decisions responding to short-term inflationary shocks.
- Credibility is strongly related to transparency and communication quality.
- There is scope for increasing central bank transparency in the region to enhance credibility, which would:
  - Help the public better anticipate central bank decisions.
  - Align medium-term inflation expectations with central bank objectives.
  - Strengthen effects of monetary policy changes and affect the procyclicality/countercyclicality of policy and potential costs of policy changes.
- Communication strategy matters for predictability: both what is published and how it is communicated to the general public.
- Central banks that explicitly provide policy guidance (for example, an easing or tightening “bias”) conditional on current forecasts considerably improve transmission of policy rates to long-term inflation compensation measures.
- Recommended steps to strengthen transparency frameworks:
  - Fill current data gaps, for example, by increasing the horizon of survey-based expectations.
  - LA5 central banks could consider publishing the votes and comments of individual committee members.
  - Central banks that do not publish minutes of policy meetings should consider publishing them; the lag in publication of minutes can also be reduced.
- Caveat: transparency and communication are not a panacea; strategies must be tailored to policy objectives.

### Box: Obtaining inflation expectations from bond prices (affine model approach)
- Rationale:
  - Agents’ inflation expectations are key to household and firm decisions but are difficult to observe.
  - Surveys of professional forecasters are infrequent, subject to lag, cover few horizons, and can exhibit bias and inertia.
  - Inflation-linked bond markets are thin in Latin America; inflation options markets are absent.
- Method:
  - Gimeno and Marqués (2012) approach used to obtain inflation expectations using standard nominal bonds in an affine framework that takes as factors the observed inflation and parameters generated in zero coupon yield curves.
  - Government bond data from four countries were used: Brazil, Chile, Colombia, Mexico.
  - Model allows decomposition of nominal interest rates into real risk-free rates, expected inflation, and the risk premium, yielding measures of inflation expectations free of risk premiums.
- Findings:
  - Inflation expectations computed for one-year, five-year, and ten-year horizons and compared with inflation-targeting levels established by central banks.
  - Brazil and Colombia show similar patterns across horizons; Chile and Mexico show more volatility at the one-year horizon and little change over longer horizons.
  - Most countries show long-horizon inflation expectations within central bank window limits, though Brazil and Colombia experienced periods with expectations well above these limits before a large decrease since the beginning of 2016.
  - Mexico shows long-term inflation expectations slightly above the window limit of 4 percent, mainly due to recent peso movements amid uncertainties about trade relations with the United States.
  - Brazil’s deep recession of 2015–16 affected expectations, which saw a large decrease since the beginning of 2016; at end-2016 expectations began increasing for longer horizons.
  - In Colombia, a series of policy hikes in 2016 appear to have anchored inflation expectations closer to the central bank target.
  - Chile experienced a decreasing trend in short-term expectations implicit in debt markets since mid-2014; short-term expectations remain below the inflation target while long-term expectations are broadly aligned with the medium-term target.
- Forecast accuracy:
  - Forecasting accuracy of inflation expectations from the affine model is compared with survey-based expectations via mean square error (MSE) ratios (table referenced in source).

*International Monetary Fund | April 2018*

### Box 3.1. Inflation Expectations from Financial Instruments in Latin America

### Box 3.1. Inflation Expectations from Financial Instruments in Latin America

### Summary of main findings
- Inflation expectations inferred from financial instruments and from surveys both produce lower mean square error (MSE) than a unit root prediction (that inflation will remain the same as today).
- Comparing survey-based expectations and model-based expectations:
  - Survey expectations show lower MSE for Brazil, Colombia, and Mexico.
  - Model expectations show lower MSE for Chile.
- A simple average of the two expected values (Survey-Model) provides lower MSE for all countries except Brazil, indicating that model-based expectations complement survey-based expectations and provide additional forecasting information.
- Expected inflation horizons used:
  - 12 months for Brazil, Colombia, and Mexico.
  - 11 months for Chile.

### Expected Inflation Forecast Errors (Table 3.1.1)
- Ratio of mean square error (MSE) of expected inflation from surveys and our model with respect to the MSE of prediction using current inflation as the predicted value. Survey-Model uses as predicted values the average of the expected inflation from the survey and our model.
- Country sample periods and MSE ratios:
  - Brazil — Sample: February 2007–October 2016
    - Survey: 0.5833
    - Model: 0.8812
    - Survey-Model: 0.6178
  - Chile — Sample: July 2012–December 2016
    - Survey: 0.7813
    - Model: 0.6344
    - Survey-Model: 0.6187
  - Colombia — Sample: February 2005–November 2016
    - Survey: 0.7956
    - Model: 0.9356
    - Survey-Model: 0.7898
  - Mexico — Sample: May 2011–November 2016
    - Survey: 0.6350
    - Model: 0.7078
    - Survey-Model: 0.6349

### Inflation expectations from financial instruments at different horizons
- Figure 3.1.1 presents inflation expectations inferred from financial instruments at horizons of One year, Five years, and Ten years, with comparison to the Inflation target.
- Time span in the panels: July 2012 through July 17 (panel ticks at July 13, July 14, July 15, July 16, July 17 are shown).
- Countries illustrated: 1. Brazil; 2. Chile; 3. Colombia; 4. Mexico.
- Data sources: Bloomberg Finance L.P.; and authors’ estimates.

### Chile case: credibility, communication, and policy framework
- Historical context:
  - After a period of convergence in the 1990s, Chile adopted a free-floating exchange rate and an inflation-targeting regime in September 1999.
  - Inflation since 2000 has averaged 3.2 percent, almost exactly in line with the Central Bank of Chile’s (CBC’s) point target.
  - Medium-term expectations have been well anchored around the CBC’s target, with medium-term expectations rarely deviating by more than a few basis points even when actual inflation spent long periods above target (for example, after the strong depreciation of the peso in 2013–14).
- CBC emphasis on communication and transparency has contributed to credibility; following reforms, the CBC’s transparency score can be estimated at 11.5 on the Dincer and Eichengreen (2014) scale.
- Reforms implemented in September 2017 aimed at improving the quality of information available to the public include:
  - Reducing the frequency of monetary policy meetings.
  - Aligning meetings with the release of the Monetary Policy Report.
  - Including additional information in statements (vote tally, main arguments by Board members, and the macro context).
  - Introducing publication of full meeting transcripts with a 10-year lag.
- Expected effect of reforms:
  - Reduce the number of major communication events (meeting statements and report releases) from 16 to 8 a year.
  - Increase the informational content of each event.

### Central Bank of Chile: current monetary policy transparency outlets (key elements)
- Monetary Policy Report:
  - Released in Spanish and English each quarter, or at every other policy meeting.
  - States policy objective to return inflation to target within the policy horizon of two years.
  - Communicates key forecasts such as growth and inflation fan charts and (infrequently) estimates of unobservables such as potential growth rate.
- Statements:
  - Published in Spanish following each monetary policy meeting; English translation released in parallel with Spanish taking precedence.
  - Report decisions, explain recent developments and expected future trends of key variables and risks.
  - Almost half the statements since 2011 have included clear guidance about the likely future path of monetary policy, explicitly conditional on current forecasts.
  - Since September 2017, statements have included information on arguments made by board members and their votes.
  - The statement issued February 1, 2018, was the first in the new format and was 3.5 times longer than the average statement in 2017; language complexity remained broadly unchanged and in line with the business section of El Mercurio.
- Minutes of monetary policy meetings:
  - Released with a two-week delay since 2006.
  - Traditionally include additional information about the meeting discussion, outlook, policy alternatives considered, arguments by board members, and balance of votes.
  - Have usually had only a very small market impact, suggesting close alignment with statements.
  - Following recent changes, the amount of additional information in minutes has been reduced substantially, further reducing their likely impact on markets.

### Communication practice considerations
- Forward-looking policy organized around a medium-term objective has been crucial for enabling the CBC to communicate accommodation despite persistent deviations of actual inflation from target.
- In highly transparent central banks (for example, Czech Republic, New Zealand, Sweden), publication of the forward path for the central bank’s policy interest rate under the board’s baseline scenario, accompanied by a fan chart, aids communication by illustrating uncertainty.
- Cautions regarding publishing a forward path:
  - Must avoid confusion about the conditional nature of the published path (it should remain conditional on economic developments).
  - Publishing a forward path can expose the central bank to concerns about lack of credibility if market expectations do not align with the published forward path.

*Prepared by Yan Carrière-Swallow and Andrea Pescatori; sources as cited in the original PDF.*

### References

### References

### Key empirical findings on fiscal multipliers in Latin America and the Caribbean
- Review of 132 estimates: average multiplier for LAC = 0.3; for other emerging market and developing economies = 0.6; for advanced economies = 0.9.
- New database–based estimates cited in chapter:
  - Fiscal multipliers in the region are estimated to lie between 0.5 and 1.1.
  - For a fiscal adjustment package that raises the primary balance by 1 percent of GDP (implemented via any combination of expenditure and revenue measures), after two years output in the sample of 14 LAC economies contracts by an average of 0.9 percent, with a confidence interval between 0.6 and 1.1 at a 90 percent level.
- Labor market impact: each percentage point of GDP in fiscal consolidation raises the unemployment rate by about 0.3 percentage point after two years.
- No impact of fiscal consolidation on different measures of the Gini coefficient is found (see Box 4.1).
- Regional fiscal plans and trends:
  - Between 2016 and 2020, the cyclically adjusted primary balance for the region is expected to improve by 1.4 percent of GDP.
  - Most LAC countries closed fiscal year 2017 with primary deficits that exceed their debt-stabilizing levels; public debt ratios in LAC have risen sharply and now stand well above the average for other emerging economies.

### Data and empirical framework
- New narrative database: fiscal actions identified in the narrative record for 14 LAC economies between 1989 and 2016 (countries included: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Jamaica, Mexico, Paraguay, Peru, and Uruguay).
- Additional samples and exercises:
  - Forecast errors for public expenditure, public investment, and public consumption from IMF’s World Economic Outlook since 1990 (sample includes 19 LAC countries).
  - Country-by-country SVARs following Blanchard and Perotti (2002) for eight Latin American countries (Brazil, Chile, Colombia, Dominican Republic, Mexico, Paraguay, Peru, and Uruguay).
- Estimation approach: common local projections specification controlling for region-wide drivers of fiscal policy and output and country-specific commodity export revenue; cumulative fiscal multiplier defined as "for each unit of fiscal action over h years, by how many units does GDP change?" (integral multiplier).

### Identification methods and their limitations
- Narrative method:
  - Uses contemporaneous documents (budgets, speeches, third-party reports) to assess motivations behind fiscal decisions.
  - Intended to reduce endogeneity by excluding actions driven by current or prospective economic conditions.
  - Limitations: relies on researcher judgment, local knowledge, and may still capture anticipated actions.
- Forecast error approach:
  - Identifies fiscal actions using forecast errors for public expenditure.
  - Advantage: actions are, by construction, unanticipated.
  - Limitations: quality depends on forecasts' bias/inefficiency/inaccuracy; forecast errors may reflect other factors (relative price changes, data revisions).
- SVAR approach:
  - Widely used, implemented with quarterly data.
  - Limitations: strong identifying assumptions (e.g., government spending cannot respond to news within three months) and may identify anticipated actions.

### Interpretation and contextual factors
- Theoretical determinants of multiplier size in LAC:
  - Factors that can reduce multipliers: potential surge in confidence from consolidation, elevated perceived sovereign default risk implying high returns to credibility, high import-to-GDP ratios (which dampen domestic demand effects).
  - Factors that can increase multipliers: tight credit constraints in the private sector, less flexible exchange rates, and acute distortions or large output slack (multipliers possibly reaching 3 or 4 in extreme cases).
- Empirical takeaway: theoretical considerations do not yield a clear prior on multiplier size in LAC; empirical estimation is required and yields multipliers that are broadly similar to those found in advanced economies when using comparable narrative methods.

### Policy implications and recommendations
- Consolidation will be contractionary in the short run: estimated multipliers imply notable output costs (average 0.9 percent output decline after two years for a 1 percent of GDP consolidation).
- Despite short-run contraction, estimated multipliers are small enough to suggest that consolidations will improve debt dynamics, even in the short run.
- Because expenditure multipliers vary with instrument:
  - Consolidation plans should preserve public investment to support growth and employment.
- When designing fiscal adjustment, consider:
  - The composition of measures (expenditure vs. revenue; protecting growth-enhancing spending).
  - Labor market structure (large informal sectors can mitigate measured unemployment responses but raise distributional concerns).
  - External openness and import content, which can alter the domestic incidence of consolidation.

*International Monetary Fund | April 2018*

### 4. FIsCAL MULTIpLIERs: HOW WILL CONsOLIdATION AFFECT LATIN AMERICA ANd THE CARIbbEAN?

### 4. FIsCAL MULTIpLIERs: HOW WILL CONsOLIdATION AFFECT LATIN AMERICA ANd THE CARIbbEAN?

### Key empirical findings
- Fiscal consolidation in LAC leads to an improvement of the external current account balance of approximately one-to-one, consistent with the twin deficits view.
- Fiscal consolidation leads to a depreciation of the real effective exchange rate of close to 3 percent.
- No significant difference is found in fiscal multipliers depending on whether the economy is in a period of slack (multiplier estimate conditioned on the sign of the output gap one year prior to the fiscal shock).
- Multipliers for consolidation packages in LAC produce an output multiplier between 0.6 and 1.1 after two years.
- Using all three identification strategies (SVAR, forecast errors, narrative), the likely range for spending multipliers in LAC is between 0.5 and 1.1 after two years.
- The multiplier for public investment reaches almost 1.5 after two years.
- The multiplier for primary expenditures is 0.5 after two years.
- The public consumption multiplier is equal to –0.6 after two years (implying an expansionary effect from cutting this type of spending, though identification is problematic for public consumption in LAC).
- No compelling evidence is found for a difference between spending cut and tax hike multipliers in LAC.
- Periods of high perceived sovereign default risk are associated with smaller contractionary effects of consolidation: multiplier of 0.6 after two years in high-risk economies versus 1.1 in low-risk economies (index of perceived sovereign risk from Institutional Investor LLC; sample split at the median).
- Suggestive evidence that Emerging Markets Bond Index sovereign spread falls by about 100 basis points after two years in the sample of 14 economies with narrative episodes.

### Macroeconomic impacts and labor market
- Consolidation packages are associated with:
  - Real GDP: contractionary effects reported (cumulative multipliers shown in figures).
  - Unemployment: increase of 0.3 of a percentage point in the narrative-sample exercise (reported in welfare/inequality discussion alongside a reduction in output of about 1 percent).
- The estimated impact of fiscal consolidation on the level of regional output will be between 0.7 and 1.5 percent during 2016–20 (variation across countries depending on the size of their adjustment plans).
- On average, LAC countries are expected to undertake fiscal consolidation amounting to 1.4 percent of GDP between 2016 and 2020.

### Composition of adjustment: implications for growth
- Expenditure composition matters:
  - Public investment cuts have much larger negative growth effects (multiplier almost 1.5 after two years) than cuts to primary expenditures (0.5 after two years).
  - If adjustment is implemented exclusively through public investment cuts, the short-term impact on regional output would be expected to reach 2.1 percent over 2016–20.
- No large differences are found between tax-based and expenditure-based consolidations in LAC multipliers, unlike some evidence for advanced economies.
- The narrative identification approach tends to yield somewhat larger multipliers than SVAR and forecast-error methods, but confidence intervals overlap.

### Confidence and state-dependence
- Consolidation implemented when perceived sovereign risk is high tends to be less contractionary (multiplier 0.6 after two years) than when perceived sovereign risk is low (multiplier 1.1 after two years), possibly reflecting confidence effects (lower interest rates, easing fiscal burdens, crowding in private investment).
- Despite possible confidence effects in high-risk settings, fiscal consolidation remains contractionary in all cases in the sample.
- Multipliers in LAC appear broadly constant over the business cycle (no significant state dependence with respect to output gap).

### Debt dynamics and short-term stabilization
- The objective of consolidation is to stabilize the debt-to-GDP ratio rather than the nominal amount of debt.
- Using the estimated range of multipliers and the levels of debt and size of government observed on average in the region, the range of multiplier estimates is not large enough to trigger unfavorable debt dynamics in the short term.
- However, absence of demonstrable improvements in the first few years can endanger sustained implementation if public support weakens.

### Fiscal consolidation and income inequality (Box 4.1)
- Analysis uses the 14 LAC countries with narrative-identified fiscal shocks and local projections; inequality measured by market and disposable income inequality in SWIID 6.1 (period of estimation 1989–2016).
- Aggregate result: fiscal consolidations have very little effects on income inequality in LAC.
  - Point estimates are small and not statistically significant: market Gini increases by 0.03 units after two years.
  - Disposable income Gini is relatively insensitive to fiscal consolidation shocks.
- Focusing on expenditure cuts:
  - A moderate increase in income inequality is observed.
  - The increase in market Gini is more persistent; disposable Gini increases more than market Gini in years 0 and 1, implying a decrease in fiscal redistribution—consistent with expenditure cuts reducing transfers.
  - By year 2, fiscal redistribution partially offsets the increase in market Gini.
- These results contrast with stronger inequality effects found for advanced economies, but align with previous evidence for Brazil.

### Policy implications and recommendations
- Fiscal consolidation in LAC will hurt growth and employment in the short term; policymakers should plan to mitigate short-term costs while stabilizing debt.
- Governments should design consolidation composition to minimize growth drag:
  - Favor plans that preserve public investment where possible, given the high multiplier for public investment.
  - Avoid implementing adjustment exclusively through public investment cuts, which would substantially increase the short-term output cost (expected 2.1 percent decline if all adjustment via public investment cuts).
- Consolidation pursued during periods of high perceived sovereign default risk may be less contractionary and thus can be an opportune moment to undertake action, possibly benefiting from confidence effects.
- Given that multipliers appear broadly constant over the business cycle, timing on this margin may be less critical except when confidence effects are likely to be strong.

*International Monetary Fund | April 2018*

### 2. Expenditure Cut

### 2. Expenditure Cut

### Empirical Evidence on Fiscal Multipliers in Latin America and the Caribbean
- Meta-study summary of 132 recent estimates; fiscal multiplier defined as the change in GDP over a two-year horizon in response to a fiscal adjustment of 1 percent of GDP.
- Key findings:
  - Fiscal multipliers in Latin America and the Caribbean (LAC) average less than 0.3 and have a high proportion of estimates concentrated just above zero.
  - Estimates for other emerging market and developing economies (Other EMDE) average 0.6.
  - Estimates for advanced economies average 0.9.
  - Studies using the narrative approach obtained larger multipliers (median multiplier of 1.1).
  - Studies using VAR-based or alternative approaches obtained smaller multipliers (median multiplier of 0.4).

### Methodology: Local Projections and Dependent Variables
- Macroeconomic impacts estimated using the local projections method of Jordà (2005) in a panel setting, as represented in equation (A4.1.1).
- Dependent variables include real GDP, the unemployment rate, the current account balance as a share of GDP, and the real effective exchange rate.
- Country fixed effects (αc) and year fixed effects (γt) are included.
- For stationary variables, yc,t enters in levels; otherwise natural logarithms are used.
- Control vector Xc,t contains:
  - two lags of the growth rate of the dependent variable,
  - two lags of the fiscal shock,
  - contemporaneous growth rate of commodity export revenues as a share of GDP and two of its lags (calculated using trade data from the United Nations Comtrade database of 33 commodities with world prices reported in the IMF’s International Financial Statistics).

### Definitions and Construction of Fiscal Shocks
- Fiscal shocks Shockc,s are externally identified fiscal actions based on three methods:
  - country-by-country Blanchard-Perotti (2002) SVAR models;
  - the narrative study described in David and Leigh (forthcoming);
  - the forecast-error approach.
- Shocks are expressed as a percentage of GDP; SVAR and forecast-error shocks truncated at the 2nd and 98th percentiles.
- When real GDP is the dependent variable, the estimated parameter β̂h is interpreted as the cumulative fiscal multiplier at horizon h.

### Narrative Approach Identification
- Consolidation episodes constructed by examining contemporaneous policy documents to assess motivation, expected size, and timing.
- Sources include IMF staff reports, OECD Country Economic Surveys, and budget-related documents.
- Included only policy actions motivated by a desire to reduce an inherited deficit and/or to address a high level of debt, or for long-run considerations unrelated to the cycle (following Romer and Romer (2010) and Devries and others (2011)).
- Excluded episodes primarily driven by responses to current or prospective economic conditions and spending-driven tax changes motivated by contemporaneous spending shifts.
- Magnitude of policy changes measured by revenue or expenditure impact at implementation (annual terms) relative to prevailing GDP; announced-but-not-implemented measures excluded.

### Forecast-Error Approach Identification
- Forecasts taken from October publications of the IMF’s World Economic Outlook (WEO); first-release outcomes taken from the WEO of the following year.
- Forecast errors constructed for annual growth rate of public consumption (series code ncg) and public investment (series code nfig), deflated by growth rate of the GDP deflator (series code ngdp_d) from contemporaneous vintages.
- Forecast errors multiplied by average ratio of nominal spending to nominal GDP (ngdp) for each country over the sample.
- Sign convention: positive value corresponds to an unexpected cut to spending.
- Forecast errors for primary expenditure constructed as sum of forecast errors for (real) public consumption and investment.
- To mitigate inflation surprises and endogenous output responses, regression of forecast errors on forecast errors of inflation and real GDP growth used; residuals used as Shockc,s in equation (A4.1.1).

### SVAR Identification (Blanchard-Perotti)
- Country-by-country SVARs following Blanchard and Perotti (2002) identify exogenous movements in government spending and tax revenues.
- Reduced-form VAR Xt = A(L, q) Xt−1 + et with Xt = [St, Tt, Yt]' (log quarterly spending, tax revenue, and GDP in real per capita terms).
- Linear relationships between reduced-form residuals et and structural shocks ut given by equations (A4.1.2)–(A4.1.4).
- Timing and identification assumptions:
  - government does not change spending as a reaction to what happens to GDP within the quarter (b1 = 0);
  - decisions on spending are taken before taxation (b2 = 0);
  - Blanchard and Perotti estimate a1 (elasticity of tax base to GDP) outside the system, often assumed to be 2 for comparability.
- Quarterly data availability restricts LAC sample to eight countries: Brazil, Chile, Colombia, Dominican Republic, Mexico, Paraguay, Peru, and Uruguay.
- Variables used: government revenue net of interest payments and part of subsidies and transfers; government spending including wages, goods and services, investment, remaining transfers; country GDP.
- Terms-of-trade index and trade-weighted foreign partners’ GDP included as exogenous variables in SVARs.

### Comparison of Identification Strategies and Shock Properties
- Narrative shocks display a smaller range and variability than SVAR and forecast-error shocks.
- Pairwise correlations:
  - Only narrative shocks have a significant correlation with the change in the cyclically adjusted primary balance (CAPB).
  - Forecast-error and SVAR shocks have very low correlations with other shocks and with CAPB.
  - Implication: alternative identification strategies capture different concepts not always closely related to overall change in the fiscal balance.

### Annex Table 4.1 — Comparing Fiscal Shocks in LAC across Methodologies (exact reported entries)
1. Summary Statistics
- Narrative
  - Packages143920.20.00.6
  - [20.9, 4.1]
  - Spending measures143920.10.00.2
  - [20.5, 2.0]
  - Tax measures143920.10.00.4
  - [20.9, 4.1]
- Forecast errors
  - Primary expenditures19532
  - 20.120.1
  - 1.6
  - [27.2, 7.8]
  - Public consumption195700.00.00.9
  - [24.1, 4.1]
  - Public investment19672
  - 20.120.2
  - 1.2
  - [24.7, 5.5]
- SVAR
  - Primary expenditures  81540.00.01.4
  - [22.7, 4.2]

2. Pairwise Correlations (entries as reported)
- Narrative
  - Packages1.00
  - Spending0.681.00
  - Tax0.910.331.00
- Forecast errors
  - Primary expenditures0.110.120.071.00
  - Consumption0.050.030.040.561.00
  - Investment0.100.140.050.77
  - 20.01
  - 1.00
- SVAR
  - Primary expenditures0.040.070.00
  - 20.0320.16
  - 0.091.00
- CAPB Change
  - 0.380.310.320.130.040.150.041.00

(Note: Table entries preserved exactly as they appear in the source.)

### Policy-Relevant Findings and Recommendations
- Empirical evidence indicates relatively small average fiscal multipliers for LAC (average less than 0.3), but estimates vary substantially by identification method (narrative median 1.1 vs VAR-based/alternative median 0.4).
- Policy recommendations and considerations reflected in the chapter narrative:
  - Recalibrate policies to sustain social progress in a tighter fiscal envelope following the end of the commodity boom.
  - Increase personal income tax revenues while rebalancing spending to help maintain key social transfers and infrastructure spending.
  - Improve targeting of social transfers.
  - Reform decentralization frameworks to support fiscal and social objectives.

*International Monetary Fund | April 2018*

### chapter is based on a forthcoming IMF Departmental Paper that

### 5. Poverty and Inequality in Latin America: Gains during the Commodity Boom but an Uncertain Outlook

### Panoramic View of Social Gains during the Commodity Boom
- Overall, poverty reduction was strong across the region during the commodity boom, especially in South America.
- Inequality as measured by the Gini coefficient declined in both Central and South America, but significantly more in South America.
- Country coverage for analysis includes Argentina, Belize, Bolivia, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, and Uruguay.
- Commodity exporters (determined when net commodity exports surpassed 10 percent of total exports plus imports at the time of the October 2015 WEO, with Brazil added because of large estimated natural resource reserves) include: Argentina, Brazil, Bolivia, Chile, Colombia, Ecuador, Honduras, Paraguay, and Peru.
- The end of the boom is defined as the start of the 2014 oil price shock for comparability across countries.
- Key observations:
  - South America experienced the largest declines in poverty and inequality compared with the 1990s.
  - For poverty reduction, South America showed higher average real GDP growth during the boom relative to the 1990s, while Central America saw lower but still high growth.
  - For each additional percentage point of growth, South American countries reduced poverty by more than other emerging regions (South American countries generally fall below the fitted line relating growth to poverty reduction).

### Commodity Cycles, Poverty, and Inequality — Is There a Statistical Association?
- The correlation between reductions in poverty and inequality during the boom and the change in commodity terms of trade is notable:
  - For noncommodity exporters, there is no clear association between changes in commodity terms of trade and those in poverty and inequality.
  - For commodity exporters, the relationship is strong, particularly for poverty: the size of poverty reduction is directly proportional to the growth rate of the commodity terms of trade in commodity exporters.
  - For inequality, a relationship for commodity exporters is visible but not as strong as for poverty.
- Empirical approach and notes:
  - The commodity terms-of-trade measure captures the income gain or loss a country experienced during the period due to commodity price movements.
  - The analysis distinguishes between CAPDR (Central America, Panama, and the Dominican Republic) and Mexico (red dots) and South America (blue dots) in scatter plots.
  - Honduras is classified as a commodity exporter by net export criteria but experienced declining commodity terms of trade during the period because it exports nonextractive commodities and imports extractive ones whose prices increased by more, producing a negative wealth effect for Honduras.
- Poverty metric used: headcount ratio at $3.10 a day (PPP).

### Commodity Terms of Trade and Income Shares by Decile (Commodity Exporters)
- Regression results (Table 5.1) of (Log) Net commodity Price index on income share by decile for commodity exporters, period 2000–14, with country fixed effects and GDP per capita control:
  - Decile 1: coefficient 0.151 (standard error 0.120)
  - Decile 2: coefficient 0.395** (standard error 0.191)
  - Decile 3: coefficient 0.392* (standard error 0.207)
  - Decile 4: coefficient 0.405* (standard error 0.226)
  - Decile 5: coefficient 0.476** (standard error 0.236)
  - Decile 6: coefficient 0.575** (standard error 0.255)
  - Decile 7: coefficient 0.716*** (standard error 0.267)
  - Decile 8: coefficient 0.790*** (standard error 0.259)
  - Decile 9: coefficient 0.436 (standard error 0.301)
  - Decile 10: coefficient −4.310** (standard error 1.735)
- Additional table details:
  - Observations: 114 for each decile regression
  - R-squared values: 0.608 (Decile 1), 0.627 (Decile 2), 0.664 (Decile 3), 0.674 (Decile 4), 0.685 (Decile 5), 0.658 (Decile 6), 0.604 (Decile 7), 0.488 (Decile 8), 0.020 (Decile 9), 0.638 (Decile 10)
  - Number of countries: 9 (commodity exporters sample)
  - Significance notation: * p < 0.10; ** p < 0.05; *** p < 0.01
- Interpretation of regression results:
  - Income shares of the second to eighth deciles increased significantly with higher commodity terms of trade, while the share of the top decile declined substantially on average.
  - The bottom income decile did not see a statistically significant increase in its income share in response to higher commodity terms of trade, although its absolute income rose.
  - Poverty reduction was driven more by developments closer to the poverty line (second to fourth decile), consistent with microdistributional changes.

### Channels through Which Commodity Cycles Affect Social Outcomes
- Market and private sector channels:
  - Expansion of the booming commodity sector draws in labor and resources, raising labor demand and pushing up real wages and/or employment.
  - Improved terms of trade and commodity-sector expansion raise domestic demand, benefiting the nontradable sector; higher commodity-sector investment can boost construction and related activities.
  - Changes in relative wages can compress or expand the skills premium depending on labor-intensity patterns; a compression in the skills premium benefits lower-skilled workers and can reduce inequality.
  - Potential adverse effect: Dutch disease—expansion of the nontradable sector and real exchange rate appreciation can crowd out the noncommodity tradable sector; offsetting positive spillovers may occur if tradable inputs are supplied locally.
- Fiscal channels:
  - Higher fiscal revenues during a commodity boom enable higher government investment, which increases domestic demand and can raise wages and reduce poverty and inequality.
  - Larger government transfers, particularly if targeted toward lower-income individuals, directly reduce poverty and inequality.
- Other general equilibrium effects (not main focus here):
  - Transmission via migration and the financial system may also matter.

### Regional Macroeconomic Evidence and Mechanisms Observed
- Empirical patterns during the boom (2000–14):
  - Public investment and employment growth were higher in commodity exporters than in noncommodity exporters.
  - Commodity exporters experienced significantly larger real labor income gains than noncommodity exporters across all skill levels.
  - Low-skilled workers gained the most on average in commodity exporters, compressing the skills premium and reducing inequality.
  - The reduction in the skills premium partly reflects demand-side factors from the commodity boom and partly an increase in the supply of high-skilled labor (per Messina and Silva 2018).
  - Government transfers increased more in commodity exporters than in noncommodity exporters.
- Aggregate implication:
  - Commodity booms reduced poverty and inequality through labor market developments (employment and real wages across skill levels) and via fiscal transfers and public investment.

*Source: Chapter based on a forthcoming IMF Departmental Paper; Regional Economic Outlook: Western Hemisphere, International Monetary Fund | April 2018.*

### 5. pOvERTy ANd INEqUALITy IN LATIN AMERICA: GAINs dURING THE COMMOdITy BOOM BUT AN UNCERTAIN OUTLOOK

### 5. pOvERTy ANd INEqUALITy IN LATIN AMERICA: GAINs dURING THE COMMOdITy BOOM BUT AN UNCERTAIN OUTLOOK

### Micro-data case studies: Bolivia, Brazil, and Peru — drivers of poverty and inequality declines
- Countries studied: Bolivia, Brazil, Peru. All experienced significant reductions in poverty and inequality and are commodity exporters (Brazil more diversified).
- Methodology:
  - Shapley decompositions of household survey data for Bolivia (2013 vs 2007) and Peru (2011 vs 2007) to isolate contributions of labor income and transfer income.
  - Within-country municipal-level analyses for Brazil and Bolivia to disentangle fiscal windfall effects from other market impacts.
- Key methodological notes:
  - Official household survey data used; official poverty lines applied.
  - Shapley decomposition isolates contribution of a specific factor by calculating a counterfactual distribution holding others constant.

### Labor income, employment, and transfers — Bolivia and Peru findings
- Bolivia:
  - Real labor income increased for all skill segments except the highest during the boom.
  - Largest gains for workers with intermediate education.
  - Employment winners by sector: extractive sector and commerce; in numbers of jobs created, broad services contributed most.
  - Average wages in extractive sector fell (compositional effect: informal miners increased faster than employees in larger capital-intensive mines).
  - Government transfers increased markedly during the boom, partly reflecting introduction of a noncontributory pension scheme.
  - Table 5.2 (Bolivia): Composition of household total income (2006–2013):
    - Labor: 82.8, 82.4, 81.8, 80.9, 79.1
    - Nonlabor: 16.4, 17.0, 17.9, 18.4, 20.4
    - Of which: Transfers from government: 5.7, 5.4, 9.8, 11.2, . . .
- Peru:
  - Employment winners by sector: construction and extractive sector; broad services contributed most in absolute job numbers.
  - Manufacturing performed poorly in employment and wages.
  - Government transfers did not increase substantially.
  - Table 5.2 (Peru): Composition of household total income (2007–2011):
    - Labor: 83.6, 84.2, 84.9, 84.8, 85.8
    - Nonlabor: 16.4, 15.8, 15.1, 15.2, 14.2
    - Of which: Current transfers1: 9.4, 9.0, 9.0, 8.6, 8.3
    - Of which: Programa JUNTOS: 0.5, 0.7, 0.3, 0.3, 0.3
  - Note: Transfers account for a much smaller share of income than labor income in both countries, limiting scope to reduce poverty and inequality.

### Shapley decomposition results — sectors and skill levels
- Overall result: Labor income played a larger role than nonlabor income in reducing inequality and poverty for both Bolivia and Peru.
- Sectoral contributions:
  - Changes in labor income of the nontradable (services) sector explain much of the social progress.
- Skill-level contributions:
  - Low-skilled workers (complete primary or incomplete secondary education) were major contributors to the fall in poverty and inequality.
  - Skilled workers (complete secondary or tertiary education) also contributed to poverty reduction because wages at the lower end of their distribution increased, enabling many skilled workers near the poverty line to exit poverty.
- Figures and magnitudes from Shapley decompositions (Figure 5.18) show specific poverty and inequality changes by sector and skill level (poverty changes in percentage points; Gini coefficient change based on rescaled gini coefficients in the range (0–100)).

### Municipal-level analysis — breadth and the role of resource-producing municipalities
- Breadth of poverty reduction:
  - Poverty fell in 97 percent of Bolivian municipalities and in 99 percent of Brazilian municipalities between the two census rounds.
  - Average municipal poverty decline: Bolivia: 14 percentage points; Brazil: 18 percentage points.
- Natural resource production concentration:
  - Many municipalities produce natural resources, but production is regionally concentrated.
  - In Brazil, top 20 producers account for 75 percent of total production (out of 5,565 municipalities).
  - In Bolivia, Tarija produced about 70 percent of total natural gas in 2012.
- Impact of being a resource-producing municipality:
  - Brazil:
    - Higher real values of natural resource production associated with larger declines in poverty.
    - Producer municipalities reduced poverty by 1.4 percentage points on average relative to nonproducer ones.
  - Bolivia:
    - Natural resource municipalities reduced poverty by 2.7 percentage points more than other municipalities.
  - Inequality results for Brazil are mixed and depend on technique; poverty effects are clearer.
- Table 5.3: Impact of natural resource boom on producer municipalities:
  - Brazil — Impact of increase in real per capita natural resource production (range for top 20 increases): 20.39*** to 29.1*** (Poverty); 0 to 20.05** (Gini Coefficient)
  - Brazil — Impact of being a natural resource producer municipality (dummy): 21.44*** (Poverty)
  - Bolivia — Impact of being a natural resource producer municipality (dummy): 22.75* (Poverty)
  - Note: *p , 0.10; **p , 0.05; ***p , 0.01.

### Disentangling channels: fiscal windfalls versus labor-demand effects
- Analytical strategy:
  - Brazil: Distinguish offshore oil and gas production (minimal local labor demand, proxies the pure fiscal channel) from domestic mineral mining (yields labor demand and local production effects).
  - Bolivia: Distinguish onshore gas megacampos (large fiscal windfalls) from mineral mining (local labor demand).
- Brazil empirical findings (Table 5.4 and Figure 5.21 summary):
  - Change in mineral production per capita:
    - Natural resource royalties per capita: 0.0174*** (standard error 0.000922)
    - Current revenues per capita: 0.0241*** (standard error 0.006010)
    - Share of workers in extractive industries: 1.33e-05*** (standard error 0.000004)
  - Change in offshore oil and gas production per capita:
    - Natural resource royalties per capita: 0.0209*** (standard error 0.001300)
    - Current revenues per capita: 0.0248*** (standard error 0.002640)
    - Share of workers in extractive industries: 22.56E-06 (standard error 0.000002) — not positive for employment
  - Geographic controls, dependent variable in 2000, and state fixed effects included in regressions; observations and R-squared:
    - Column (1) Observations: 5,507; R-squared: 0.886
    - Column (2) Observations: 4,982; R-squared: 0.834
    - Column (3) Observations: 5,507; R-squared: 0.223
- Interpretation:
  - Offshore oil and gas (fiscal channel) led to reductions in poverty and a marginal increase in labor formality in Brazil.
  - Mineral mining increased municipal revenues and local extractive employment, indicating combined fiscal and labor-demand impacts.
  - In Bolivia, gas megacampos produce larger fiscal windfalls while mineral mining generates substantial local labor demand; analysis less precise due to data limitations.

### Summary of substantive findings and policy-relevant implications
- Main drivers of poverty and inequality declines during the commodity boom:
  - Labor income gains, concentrated among low-to-medium-skilled workers in nontradable (services) sectors, were primary drivers.
  - Government transfers expanded in some cases (notably Bolivia) but remained smaller than labor income contributions.
  - Natural resource producing municipalities experienced larger poverty declines than nonproducer municipalities.
- Channels:
  - Both market-driven labor-demand effects (especially from mining and nontradable sector expansion) and fiscal windfalls (from offshore hydrocarbons and large gas fields) contributed to social gains, with the mix differing by country and resource type.
- Sustainability concern:
  - Whether labor-income gains—particularly for low-to-medium-skilled workers in nontradable sectors—are sustainable after the commodity boom is uncertain and requires attention to post-boom adjustment policies.

*International Monetary Fund | April 2018*

### 5. pOvERTy ANd INEqUALITy IN LATIN AMERICA: GAINs dURING THE COMMOdITy BOOM BUT AN UNCERTAIN OUTLOOK

### 5. pOvERTy ANd INEqUALITy IN LATIN AMERICA: GAINs dURING THE COMMOdITy BOOM BUT AN UNCERTAIN OUTLOOK

### Local labor-market and poverty impacts of commodity windfalls (Brazil and Bolivia)
- Brazil: A one standard deviation increase in the value of natural resource production per capita between 2000 and 2010
  - reduces the poverty rate by only 0.2 of a percentage point for most municipalities.
  - for the big producers, estimated reduction in poverty is between 3 and 9 percentage points for the top five producers.
  - labor formality increased significantly.
  - labor shifted out of agriculture and manufacturing into construction and services.
  - public sector employment increased (municipal-level regressions include the change between the 1991 and 2000 census as a control; standard errors clustered at the state level).
- Bolivia:
  - in mining municipalities the fraction of agricultural employment decreased significantly and net migration increased.
  - in gas megacampo municipalities public sector employment increased significantly—an increase of around 2 percentage points in public sector employment in gas megacampo municipalities is greater than one standard deviation (notable given the small share of public sector workers in the average Bolivian municipality).
  - impacts are larger in mineral municipalities than in megacampo municipalities in terms of labor-market effects.
- Overall: Results for Brazil and Bolivia are in line with other within-country studies in Latin America.

### Fiscal decentralization and distribution of resource revenues
- Many countries (Bolivia, Brazil, Peru) redistribute large parts of fiscal windfalls from natural resource extraction to subnational producers; Colombia redistributes royalties to subnationals with less focus on producers after a 2012 reform.
- Conceptual drawbacks of sharing large resource revenues with subnational producers:
  - Large horizontal inequities when geological differences determine fiscal envelopes.
  - Volatility of resource revenues complicates intertemporal planning at the local level.
  - Resource revenues act as transfers and do not encourage accountability or building own-revenue bases.
  - Large per capita windfalls can create absorptive-capacity and governance problems.
  - Environmental impacts of mining create a case for additional transfers to producing regions.
- Bolivia departmental budget example (2012):
  - Tarija (main gas region) had a population share of around 5 percent but accounted for over a third of all departmental revenues and wages, and nearly half of departmental capital expenditure.
  - In Peru (2012), main producing departments (Moquegua and Cusco) received more than S/ 2,000 per capita in commodity-related transfers (canons), while some other departments received less than S/ 1 per capita; 12 of the 183 provinces in Peru receive about 50 percent of canon revenues.
- Consequences observed since the boom:
  - Main commodity-producing regions (Tarija in Bolivia and Rio de Janeiro in Brazil) have suffered severe fiscal sustainability problems.
  - Governance problems and capacity constraints at the subnational level often limit the effectiveness of public spending when per capita natural resource revenues are high.

### Policy recommendations for decentralization and revenue-sharing
- When opportunities exist for substantive decentralization reforms, reforms should:
  - minimize horizontal inequities;
  - avoid boom-bust revenue cycles at the local level;
  - clarify the goals of revenue-sharing agreements.
- Specific measures:
  - use precautionary stabilization funds (examples include Chile, Colombia, and Norway) to avoid boom-bust cycles and large local spending shocks;
  - reform royalty-sharing arrangements to reduce horizontal inequities (Colombia’s 2012 reform is cited as an example);
  - build capacity at the subnational level and encourage local governments to build their own-revenue bases (for example, via property taxes) to reduce reliance on transfers;
  - make transfer arrangements as transparent as possible to facilitate planning and oversight;
  - use nonresource transfers to offset horizontal inequities by including measurable criteria of local needs in allocation formulas (for example, the equalization scheme in Canada).

### Risks to social progress after the 2014 commodity-price downturn
- Observed post-2014 developments:
  - employment growth has slowed much more in commodity exporters than in noncommodity exporters;
  - real wage growth has been negative for all skill groups (post boom 2015–16 annualized);
  - poverty rates have increased in some commodity exporters, including Brazil and Paraguay;
  - inequality in commodity exporters largely moved sideways post 2014 after the large reductions during the boom years;
  - fiscal space has fallen in many commodity exporters due to declined commodity-related revenues and slowing growth.
- Implication: Absent policy measures, lower commodity prices carry a significant risk of slower poverty reduction and possibly higher inequality in commodity exporters.

### Policy options to sustain social progress with lower commodity prices
- Central government actions, especially where fiscal buffers are limited:
  - maintain the quality of social and infrastructure spending by increasing revenues and reprioritizing spending.
  - create space for social spending by:
    - increasing revenues from progressive personal income taxes (personal income taxes in Latin America tend to be less than in other regions; effective rate for the top decile is 5.4 percent on average in Latin America, yielding limited redistributive impact);
    - reducing universal price subsidies (for example, energy subsidies) which are typically highly regressive.
  - increase efficiency of spending and better target existing social transfers through means testing where feasible.
- Fiscal federalism and subnational finance:
  - improve allocation of revenue-capacity and spending responsibilities across levels of government;
  - enhance capacity at the local level;
  - reform revenue-sharing formulas to take greater account of spending needs (for example, population size and poverty levels);
  - consider greater use of stabilization funds with clear rules and governance arrangements in commodity exporters.
- Labor market and structural policies:
  - increase labor market flexibility and deploy policies aimed at retooling workers to smooth adjustment to demand rebalancing from lower commodity prices;
  - continue structural reforms to diversify the production base to increase resilience to commodity-price shocks.
- Human capital:
  - further improvements in the quality of education should remain a priority, recognizing that gains take time and accrue in the longer run.

### Supplementary methodological notes (Annex 5.1)
- Brazil: Difference specification estimated to capture local impact of resource boom:
  - dependent variable change between 2000 and 2010 in municipality i (∆yi,2010) regressed on change in resource production per capita (∆xi,2010) measured in constant 2010 Brazilian reais, with controls for level in 2000 (yi,2000), prior change (∆yi,2000 between 1991 and 2000 when available), state fixed effects (θs), geographic controls (Zi), and state-clustered standard errors.
- Bolivia: Difference-in-differences model using 2001 and 2012 census data:
  - yit = a + EMi + Tt + (EMi* Tt) + X'it + β + εit, where EMi is a dummy for extractive-sector municipalities, Tt is a 2012 time dummy, and the interaction term is the treatment variable.
  - distinction made between mineral producers, “small” oil and gas producers, and natural gas megacampo producers.
  - entropy balancing technique used to select and weight control municipalities to achieve covariate overlap given lack of pre-2001 data.

*International Monetary Fund | April 2018*

### Annex 5.2. Details of Natural

### Annex 5.2. Details of Natural Resource Revenue Sharing in Latin America and Elsewhere

### Overview
- Natural resource revenues are largely centralized in Chile, Ecuador, Mexico, Norway, Trinidad and Tobago, and Venezuela, with either very limited or no redistribution to subnational producers.
- In the three case study countries and Colombia, significant amounts go to subnational governments.
- In Canada, provinces manage nonrenewable natural resources.

### Country-specific arrangements and key figures
- Bolivia
  - Out of the total 18 percent hydrocarbon royalty:
    - 11 percentage points go to producing departments,
    - 6 percentage points stay with the central government,
    - 1 percentage point goes to the lightly populated departments of Pando and Beni.
  - The 32 percent hydrocarbon tax (Impuesto directo a los hidrocarburos—IDH) is allocated to both producing and nonproducing departments as well as municipalities, with 20 percentage points remaining with the central government.
  - Mining royalties are distributed only to producing departments and municipalities, with an 85–15 split between the two.
- Brazil
  - Sixty-five percent of mineral royalties are distributed directly to the producing municipality, while 23 percent go to the producing state and the remainder to the federal government.
  - Since the 1997 royalties law, substantial amounts of oil and gas revenues have been distributed to municipalities that either host an onshore oil and gas field or face an offshore oil and gas field.
  - In some cases, royalties can account for over 50 percent of a municipality’s revenues.
- Canada
  - Natural resource income is subject to federal and provincial corporate income tax, and to mining taxes, royalties, and land taxes at the provincial level.
  - There is a fiscal stabilization program enabling the federal government to provide financial assistance to any province faced with a year-over-year decline in nonresource revenues greater than 5 percent and caused by an economic downturn.
  - Canada has an equalization program to reduce fiscal disparities between provinces; equalization transfers are unconditional and determined by measuring provinces’ ability to raise revenues.
- Colombia
  - Prior to the 2012 reform, roughly 80 percent of royalties went directly to producer departments and municipalities (which had only 17 percent of the population).
  - Following the 2012 reform, this was reduced to roughly 10 percent, with the remainder assigned to central funds with specific goals:
    - Around 30 percent is saved in a stabilization fund,
    - 10 percent goes to a science and innovation fund,
    - 10 percent to a regional pension fund,
    - The remainder is allocated to subnational investment projects with a relatively complex distribution formula based on poverty levels and other factors.
  - As a result, 1,089 municipalities received a share of commodity royalties in 2012 compared to 522 in 2011.
- Norway
  - Government revenues from petroleum activities are transferred to the Government Pension Fund Global.
  - Under the fiscal rule, petroleum revenues are phased into the economy gradually: over time government spending must not use any of the fund’s capital, only its expected real return, which is currently estimated at 3 percent.
  - The fiscal rule allows petroleum revenue spending to be increased during economic downturns and decreased during economic upturns.
- Peru
  - Overall, about 60 percent of fiscal revenues from the mining sector go to subnational governments, mainly consisting of mining sector corporate income taxes (canon minero) and mining royalties.
  - There are various canons and they are only transferred to the department where production of the natural resource takes place.
  - Resources are further distributed within producing departments, resulting in producing provinces and municipalities receiving a large share.

### Noted patterns and institutional features (as described)
- Centralization versus decentralization varies markedly across countries: some countries centralize natural resource revenues (Chile, Ecuador, Mexico, Norway, Trinidad and Tobago, Venezuela), while others allocate substantial shares to subnational governments (Bolivia, Brazil, Canada, Colombia, Peru).
- Allocation mechanisms can be:
  - Fixed-percentage splits (e.g., Bolivia’s hydrocarbon royalty and IDH; Brazil’s mineral royalty shares).
  - Complex formulas with multiple destination funds and conditionalities (e.g., Colombia’s post-2012 reform allocations).
  - Institutional fiscal rules and sovereign wealth fund arrangements to phase resources into the economy (e.g., Norway’s Government Pension Fund Global and its 3 percent expected real return rule).
- Subnational dependence on resource revenues can be high: royalties in some Brazilian municipalities can account for over 50 percent of municipal revenues.

*Source: Annex 5.2. Details of Natural Resource Revenue Sharing in Latin America and Elsewhere (wreo0518).*

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_Source: https://www.imf.org/-/media/files/publications/reo/whd/2018/may/wreo0518.pdf_