Preventing future macroeconomic crises by studying the past
By Monica Sather | Student reporter
Julián P. Díaz, PhD, associate professor of economics, recently presented at a conference organized by leading economists—including a Nobel Laurate—and hosted by the highly respected Becker Friedman Institute at the University of Chicago.
Díaz, along with researchers from throughout North and South America, were invited to explore the monetary and fiscal history of the 11 largest Latin American countries since the 1950s or 1960s. Díaz’s research and presentation focused on Ecuador.
By studying these countries—which have faced a number of macroeconomic crises, including defaults, devaluations, and banking crises—the conference hoped to strengthen the understanding of the causes of these crises.
Here, Díaz discusses the conference, his research on Ecuador, and why it is important for the business and Quinlan communities.
Tell me about the conference.
The conference was organized by Thomas Sargent (Nobel Laureate in Economics, 2011); Juan Pablo Nicolini; and Timothy Kehoe. Since I was born and raised in Ecuador, and macroeconomics is one of my research fields—with some of my papers focusing on the Ecuadorian economy—the organizers thought I would be a good fit to participate in the project. Simón Cueva, another Ecuadorian economist, is my co-author in this project.
The project is guided by a common methodological framework to analyze the sources of macroeconomic crises in the region. Although the studies follow the same broad methodology, the analysis at the country level also incorporates facts and features specific to each nation to obtain a more accurate understanding of the sources of macroeconomic instability in each economy.
Tell me about the project’s goals.
The project accomplishes two main objectives: the first one is the construction of a long, internationally comparable database that, starting in 1950, includes the most important fiscal and monetary variables of Ecuador. This data allows us to pursue the second objective: to determine whether bad monetary and fiscal policies are the main culprits of Ecuador’s poor macroeconomic performance during most of the second half of the Twentieth Century.
What are the key findings from your Ecuador case?
Before describing the main results, it is important to highlight that Ecuador is a unique case among the 11 economies in the project since it officially dollarized its economy in 2000. That means that Ecuador is the only country in the project that renounced its own domestic currency and adopted the U.S. dollar as legal tender.
Our analysis covers the 1950-2015 period. We found that until 1971, the Ecuadorian economy was characterized by a relatively healthy economic growth rate of 4.8 percent per year, and low inflation, which averaged close to 3 percent per year. In the early 1970s, Ecuador became an oil exporter, which coincided with a surge in the price of oil in the international markets. The new wealth led to a massive increase in the size of the government, which more than doubled relative to the pre-oil era.
However, growth in the size of the government was not accompanied by any kind of rainy-day saving. The surge in oil prices eventually came to a halt but, instead of adjusting to this new reality, the Ecuadorian government borrowed heavily from abroad to maintain its level of spending.
The Latin American Debt Crisis of the 1980s made this strategy unsustainable since international creditors stopped lending to Ecuador, and the rest of the region. This should have prompted a significant fiscal adjustment, which, however, never really took place in a significant manner. Instead, the government resorted to seigniorage—printing money—to finance a large portion of its spending. This in turn led to a lengthy period—almost three decades— of persistently high inflation, which averaged nearly 30 percent between 1972 and 1999.
This highly inflationary environment ended in the year 2000, when Ecuador dollarized after suffering the worst economic crisis in its history in 1999. Under the dollarization regime, the Ecuadorian government cannot print money, since the currency is now the U.S. dollar. Once the ability to print money indiscriminately was eliminated, inflation dropped dramatically and has averaged 4 percent since 2004, levels comparable to the ones we have in the U.S.
Why is this of interest to the business and Quinlan communities?
Businesses operate in environments influenced by governments’ actions. Identifying fiscal and monetary policies that lead to undesirable outcomes and hurt the ability of businesses to thrive is of critical importance.
For our students, many of the tools used to analyze the countries’ performances in this project are taught in a number of economics classes at Quinlan. This highlights the fact that the topics we cover in class are not just theoretical exercises. They are being used to understand why some countries fail, and what can be done so that such costly experiences are not repeated in the future.