Aggregate Volatility in Modern Latin America: Causes and Cures

37 Pages Posted: 17 Jul 2000

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 2000


Latin America has experienced deep transformations during the 1990s. In many countries of the region traditional imbalances have been largely abated, privatizations are widespread, openness of both trade and financial accounts has been largely accomplished, supervisory and enforcement institutions are steadily improving, pension systems have been modernized, and so on. Symptoms of success abound. An important exception to this rosy scenario is the untamed and widespread volatility of real and financial variables. Rather than attempting to characterize every possible shock and amplification mechanism, this paper offers a parsimonious account of volatility in countries that have already tamed most of the traditional sources of macroeconomic instability in Latin America. It builds on two widely observed weaknesses: (i) weak links with international financial markets, and (ii) underdeveloped domestic financial markets. Once interacting, these two ingredients not only explain the observed volatility but they also generate clear externalities that require policy intervention. This framework thus provides a clear foundation for policy analysis. Most other shocks and deficiencies are leveraged - even made possible - by these two factors. Moreover, to the frustration of highly competent policymakers, the environment becomes intolerant of policy mistakes.

Keywords: Volatility, Financial Constraints, Capital Flows, Terms of Trade, Banking Crises, Illiquidity, Emerging Markets, Macroecnomic Policy, Contingent Policies, Corporate Governance

JEL Classification: F3, F4, G00, O54

Suggested Citation

Caballero, Ricardo J., Aggregate Volatility in Modern Latin America: Causes and Cures (June 2000). Available at SSRN: or

Ricardo J. Caballero (Contact Author)

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