Latin America’s Challenges in an Era of Secular Stagnation


October 7, 2016, 8:45 AM to 10:00 AM EDT
PIIE Webcast, Washington, DC
Pablo García Silva (Board Member of the Central Bank of Chile)

Event Summary

Pablo García Silva, board member of the Central Bank of Chile, shared his insights in a presentation titled “Latin America’s Challenges in an Era of Secular Stagnation.”

Pablo García Silva has been a board member of the Central Bank of Chile since January 2014. Before being appointed board member, he served as executive director for the Southern Cone, of the International Monetary Fund (IMF) from November 2012. Between 2010 and 2012, he was alternate executive director, Southern Cone, of the same organization. Prior to his time at the IMF, García held different positions at the Central Bank of Chile, including director of the research division (2007–10), director of the financial policy division (August 2006–December 2007), manager of the financial stability unit (April–July 2006), and manager of the macroeconomic analysis unit (2000–2006). He earned a PhD in economics from MIT in 1999.


Unedited transcript

Adam Posen: Good morning everyone. And as my trope, welcome back to the Peterson Institute for International Economics. It is Friday morning of the 2016 IMF World Bank annual meetings and we are delighted to have a rising star in the economic policy making firmament here to enlighten us this morning.

Dr. Pablo Garcia is a Board Member of the Central Bank of Chile. He's been a Board Member since January 2014. Previously, he served as an Executive Director for the southern cone of the IMF from November 2012. And Alternate Executive Director before that. He held a distinguished career before being sentenced to purgatory here in Washington at the Central Bank of Chile, purgatory at the IMF board. I mean, that's real purgatory.

Since all the IMF people are off at the meeting now, I can say these things. He was including being our favorite director of the research department from 2007 to 2010. He has a PhD. in economics from MIT. And of course, we're grateful to our longtime colleague Jose De Gregorio, a former governor the Central Bank of Chile for encouraging us to invite Pablo. And I am grateful to Pablo for accepting our invitation.

Just one word. I'll repeat something I said yesterday but I think it bears repeating. The Institute has a long history of working on Latin American issues and reform going back to, of course, John Williamson's seminal work on the Washington consensus with now President of Peru, I believe.

Bill Cline is with us today, has long history working particularly on Brazil. We have many distinguished publications and scholars. But in recent years that we have been doing less on that and one of the things I decided a couple of years ago was to re-up our commitment to work on Latin America which is both a question of our staffing but also our activities.

And so, we are very proud to have with us now Monica de Bolle who gave an excellent presentation on the Brazilian situation yesterday. Of course, Jose de Gregorio with us part time while he is teaching at Chile.

And as well having added Chad Bown who is, of course, a trade expert who is doing a lot of work on Latin American trade issues at the World Bank before joining us.

Out internal decision decided the message I keep repeating but I'm hoping those out there in the internet will hear it is that the next American administration whatever it is, is going to have to pay a lot more attention to Latin America than this previous one as much as I love this previous administration.

There is a lot going on there. There's a lot going on there that's good. We heard something about that from Central Bank President Sturzenegger from the Central Bank of Argentina yesterday and I think we'll hear more about that from Pablo today.

There's lot that's going on there that's very challenging which we're also aware of.

The key thing is not that the US, even if it were so inclined, can come riding in and rescue this. The key thing is that there is something of a dynamic interaction in the southern cone of many countries going through potential economic regime changes for better or for worse at roughly the same time and the spillovers on let us say the good regimes like Chile and Colombia from some of the hard choices and challenges in places like Brazil and Venezuela are very real as well as the global commodity cycle.

And when it starts being a regional issue and there are people there who want to continue as the Pacific Alliance has done looking north where they're looking the integration. It's up to the US to try to enable that where it can.

So, we're grateful to Pablo Garcia to talk to us here about Latin America's challenges in an era of secular stagnation that is an important topic in its right. We will always welcome Pablo back there but in particular, I hope this would be taken as part of our trying to flag that the American Administration has to think more creatively and more engaged with Latin America.

Please let me turn now to Dr. Garcia.

Dr. Pablo Garcia: Thank you, Adam. Many thanks to the Institute for the opportunity to give this lecture on the state of Latin America's macro economy as well as the place now, we're shifting global environment.

I think this is also useful for me because it allows to think a bit beyond the short term where central banks are usually are. And have a view more on the medium term and what the challenges we face in Latin America are.

Of course, those are many. They range from short-term stabilization to the diversification of our export base, to political transitions and things like that.

We would talk about all of them at length. But, I want today to focus on a few of those only because of time and because it allows to connect with this discussion of secular stagnation that's been going on elsewhere.

The starting point of this is the fact that Latin America's growth performance is beyond underperforming. As we see currently, Latin America on average of course is about that of an emerging economy. But as a region, it has shown a dramatic downshift in growth both compared to emerging economies to advanced economies to the world economy as a whole.

So, I argue that this is because Latin America is a very open economy and therefore the slump in global trade is behind the fact that Latin America grows little.

But as we see from this figure also, trade really doesn't show of a different pattern when one compares it to the overall performance of the growth in the world.

Now, the typical thing to do when macroeconomist look at this is to think about whether this is a short term or a long term phenomena. Is this cyclical? Is this structural? And it's very hard to make that distinction today in an environment where we are seeing this situation that has been dubbed secular stagnation.

Where according to Summers, economy suffer from an imbalance resulting from an increasing propensity to save and increasing propensity to invest and the result is that excessive saving adds as a drag on demand, reducing growth and inflation, and also the imbalance between savings and investment pulls down real interest rates, end quote.

It is very hard to argue that some of these is at play globally and also it might be at play in Latin America and in other regions once one looks at what is going on with investment and growth perspectives.

Here is the change in the expected economic growth for 2016 and the expected growth in investment for the same year starting early in 2015.

And we see how every time, and this is from consensus, as time goes by we're being downshifting expectations in a very persistent way. The IMF forecasts are similar, maybe not that dramatic as these ones. And we can see that Latin America is the star of these underperformance both in terms of investment growth and as well as economic growth.

Commodity exporters, here are the New Zealand, Canada and Australia, they also show a very similar downgrade in investment perspectives as well as China. But, Latin America shines or to put it in way like that from the fact that its growth that is actually also being very much revised downward.

Now, this is in terms of the aggregates for perspectives of growth and investment and actual output but as we expose to these low trend and actual growth, low growth of real incomes, high savings relative to investment, the neutral interest rates in the world have been estimated to have declined.

Recent studies show that the neutral interest rate in the real terms in advanced economies has been going down. This had been a very persistent process overtime.

Today, even in some cases, they might be negative. And this has been one of the reasons to justify these ultra-loose monetary policies stance in major advanced economies.

Therefore, here we have these two ingredients -- very low growth perspectives in investment and the aggregate, very low real interest rates in advanced economies, ultra-loose monetary policies, all these as a result of this situation of persistent secular stagnation.

These are the debate on whether we are actually living in a secular stagnation environment. I don't want to get into that. I just want to point out that at least we need to take this as a risk and this is an important enough risk that the implications must be taken into consideration.

So, what I want to do and what follows is elaborate three main themes around this basic idea of the implications secular stagnation for Latin America.

First, I want to take a look at how these super loose monetary policy in advanced economies transmits themselves to Latin America and through the international monetary transmission mechanism and what has changed compared to the past. And not so far in the past but actually the recent past.

Earlier this decade, we also saw in the immediate aftermath of the Great Financial Crisis, extremely low interest rates in the world. And then, we had booming economies in the emerging world. Why this is not the case now? I think it has to do with these workings of the monetary transmission mechanism.

Second, secular stagnation has also implications for medium term growth and it would be useful to take a view on what are the main drivers of growth for Latin America and how secular stagnation can affect them.

Finally, I want to conclude by discussing what are the policy levels on the policy space we have to face this new challenges.

When I arrived at the hotel yesterday, I saw the new version of Latin Finance magazine that had – the main article is why Latin America is the new hot pick for the future. I don't want to be so optimistic but I want to conclude by saying that there's a silver lining in this environment that is not all black clouds.

So, let's go to the first one. The implications for extraordinary monetary measures in advanced economies. I think the good starting point for this is thinking about what the monetary transmission is and how international spillovers work through that.

And the common approach, these are a very simplified version, is to think that the expected domestic monetary policy has two main channels of transmissions towards inflation. One is the aggregate macro credit growth employment and the underlying inflationary pressures. And the second one is the exchange rate.

These two things, of course, relate to each other and they also tend to impact inflation forecasts and then you solve this and then you get the appropriate monetary stance depending on how you see inflation is going to be forecasted.

This is the actual way you solve these problems. You have to be -- everything is solved at the same time.

Once you open the economy, the way I like to look at this is that you have international monetary spillovers that operates through the same channels that domestic policy impacts domestic inflation. That is on the one hand, you have UIP considerations and risk premium which affect the exchange rate. And on the other hand, you can have capital flows and FDI and cross-border lending that impacts the real economy and therefore also generate some inflationary pressures.

What are the implications of these when you want to conduct domestic monetary policy? The typical example is let's say the early 2010's, you have loose monetary policy in advanced economies. That loose monetary policy tends to strengthen exchange rates in the emerging world because the dollar is weakening. They also create flows, capital inflows and you have a more booming economy.

Those two things have opposite effects on inflation. On the one hand, the strengthening of the exchange would reduce inflationary pressures. On the other hand, the economy is quite getting strong that increases inflationary pressures.

And the way to calibrate domestic policy is to say, “Well, which of those is the strongest channel?”

I think that once the US economy recovers, this thing goes into reverse. Monetary policy in the US gets tighter, the dollar strengthens. You have depreciating pressures in emerging economies, capital outflows, the real economy weakens. And if this leads to lower inflation prospects, then you may end up easing monetary policy domestically.

These are very stylized way of looking at the world but I think it provides an extremely good description of what has been going on in normal times that is before this current round of ultra-loose monetary policy.

If you look at the macroeconomic cycle in Latin America, I think it provides a very good sense of the qualitative implication of this transmission. You have periods of loose money in the US say in the mid-2000s or right after the crisis.

And you have capital inflows with the current account deficit, high growth, high commodity prices, strong exchange rates. Then, after the taper tantrum you have a slowdown in economic growth, a weakening currency, falling commodity prices, and it tends to describe, I think, appropriately what this transmission is.

In the case of Chile, I will briefly talk about Chile here, is even more stark. Here, you have the output gap and the real exchange rate. Again, periods of slacking the economy or periods of weak exchange rate, periods of strength or overheating in the economy.

Let's say in the mid-2000s or by 2012 were periods of strong real exchange rates and those forces in terms of their impact on inflation have a certain counterbalancing effect.

What has actually been going on with monetary policy in these periods is that the business cycle component has been more predominant. And therefore, in periods of strengthening exchange rates, monetary policy have been tighter. In periods of weak exchange rates, monetary policy has tended to be looser and this shows that precise argument the MPR, the yellow line is the actual policy.

So, you see how even though the exchange rate was pretty strong in the early 2010s, the nominal interest rates were already really high. And as the economy went into a slowdown after the taper tantrum, inflation went up because the exchange rate weakened but monetary policy still became into a more easing stance.

The interesting thing is that the bottom line, that's inflation expectations at two years stuck at 3% with very little variation which means that the system in some way has this self-stabilizing features. Thanks to the flexibility of the exchange rate.

So, taking these as a standard view, the question is why are we thinking today about the implications of ultra-loose monetary policy? We've been already there in the past.

I think that today's circumstances are both qualitatively and quantitatively very different. On the one hand, monetary policy rates have pierced their theoretical zero lower bound in significant parts of the world but also a huge quantitative easing measures have been added to the short term interest rate policy by the ECBM, the Bank of Japan, most noteworthy.

The US Federal Reserve of course is in a different situation but the fact that the monetary policy stands as being kept loose for way longer than expected a while ago I think is also a part of this very extraordinary monetary policy stance.

These are just the interest rates in the major economies.

How is the transmission of this ultra-loose monetary policy in terms of the spillovers? I think it's different from the standard case through a number of reasons.

On the one hand, these negative interest rates due to a number of regulatory or competitive reasons are not transmitted to the clients of the banks, and therefore, banks do not experience the benefits of easier access to finance.

On the second hand, that you QE policies what they have done is they have reduced yields on a whole sets of assets in the economy and therefore the curve has been flattened. This has implications for the profitability of banks.

The traditional mechanism through which a monetary policy expansion would be channeled through the real economy was through stiffening of the curve that makes credit flow easier for the banks that has not happened today. The curve has been actually flattening and therefore the traditional mechanism of transmission is not really working.

Some have argued that it can be actually operating in reverse, that these negative interest rates plus QE imply actually a negative credit impact on the economy.

The way to look at it is in terms of the international spillovers, this is a standard view and then what we would have with negative interest rates, QE and secular stagnation is that the credit channel is diminished and essentially the bulk of the transmission mechanism from loose monetary policy of the world is through the exchange rate.

Now, I think that that's one of the main reasons why today, in spite of this extra low interest rates in the world, emerging economies in Latin America in particular are not experiencing what would've been happening in the past.

The exchange rate has remained weak in general. Here, going up is the depreciation of the real exchange rate. But, still it has been appreciating a bit in the past thanks to these extra-loose monetary policies.

Capital flows unlike in the early 2000s have been flowing out of the economy. And also, there's been an impact on domestic asset markets, long term interest rates with some degree of variation across economies, of course, have been going down.

Now, another implication of secular stagnation in terms of the conduct of the monetary policy in Latin America is that it might signify that these lower neutral interest rates are also at play that therefore that we are seeing a reduction in the neutral stance of monetary policy.

And as the Central Bank of Chile, we have partly taken that into consideration into our own forecasting and policy analysis.

Now, it's also the case that dynamic growth and investment around the world takes a toll in the countries capital recommendation and perspective going forward to the extent that the saving an investment equilibrium in the advanced world tends to generate smaller current account deficits there will be pressures to push in the opposite way in emerging economies also dragging down growth.

So, this is the first thing regarding the peculiarities of the current transmission mechanism of ultra-loose monetary policy.

Second issue is what are the medium term growth challenges for Latin America? What are the traditional drivers of growth in Latin America?

First, I think there's a very clear link that appears in terms of the swings in economic growth that follow quite closely the swings in terms of trading in the Latin American economies.

But, underlying that, beyond that, we need to look at the convergence, accumulation of capital and also accumulation of human capital.

Here, I want to make a comparison with ASEAN 5 economies. I think it's a rather fair comparison. These are countries or economies that today are at the similar level of development than Latin America. They have transmitted from periods of [inaudible 0:22:01] to a higher degree of amortization and also they have abundant natural resources.

However, the patterns in terms of conversion are very, very different here. I show this is the GDP per capita in Latin America and the ASEAN 5 economies compared to the average of the G7 starting from the 80s.

And of course, today, the levels of income per capita are similar but ASEAN 5 economies have converged quite sustainably and persistently towards higher levels of per capita income.

Latin America, even after the last decade, we saw a dramatic fall in relative income has essentially stagnated.

When one looks at the recent golden period is really very small. It was a very small increase in relative incomes and going forward, looking at the way of projections, there's nothing that seems to point out toward better performance in the next few years.

As a matter of fact, recent years since 2014 have erased a sizable fraction of the relative increase in income per capita relative to the G7 that we witnessed early on this century.

Now, the underlying factor behind this very lackluster conversion in Latin America I think can be found both in capital accumulation and in educational attainment.

Here on the left is the investment rates in Asian economies and Latin America. And as we see investment rates in Latin America had been stuck in the low 20s. It is actually quite striking that the Asian crisis in the late 90s saw the investment rates in Asian economies go down to basically what Latin America has had for decades.

And then, the recovery of course is not back to the 90s but still quite significantly high around 30%.

Most worrisome on the right panel, we have educational attainment, rather years of schooling, again measured as a fraction of the G7 average. And the interesting thing here is that Latin America has been stagnating since the mid-80s whereas the Asian economies have been increasing educational attainment in a very significant way.

And currently, as of 2010, actually have surpassed Latin America.

So, the medium term challenges I believe are the same that Latin America has been facing for a long time. We don't see much new there which is obviously disappointing.

Now, let me conclude with some policy implications for Latin America.

The arguments I have outlined here present a few challenges in the area of secular stagnation in advanced economies. On the one hand, it's obviously the case that given the prevalence of a low growth scenario driven by lackluster investment poses difficulties to continue to grow through investment in the region.

Also, the implementation of ultra-loose monetary policy appears to have limited cyclical upsides for economic growth in the short term given this lopsided nature of the international monetary transmission mechanism that I have argued and most to the effect is through the exchange rate and will likely be so going forward.

However, I think that there are few silver linings in this. In the extent of the adjustment that we have seen both in the macro economy and also in society's expectations and also in the validation of standard macroeconomic frameworks.

In the three and a half years since the taper tantrum in 2013 put a sharp end to the idea that emerging economies in Latin America in particular [inaudible 0:26:06] from the international monetary transmission, Latin America has undergone a very painful process of adjustment to lower commodity prices, weaker currencies, decelerating growth and also contracting investment.

Now, this had been obviously very painful but thanks to the sustained global monetary stimulus, we haven't witness the dreaded sudden stop that most of us thought was inevitable after May 2013. We haven't seen also this dreaded current account deficit reversal.

This had been an adjustment in a more slow motion fashion than the southern crisis that we saw in the past decades.

Second, the transition from these heavy days of high commodity prices and high growth right after the Great Financial Crisis to the current state of lowered expectations, I believe is what lies behind most of the social and political tensions we have seen in Latin America.

Now, I believe it is noteworthy that with only a very few exceptions, this downshift, this adjustment of societal expectations about what the economy can deliver, for instance, systems of physical efforts for redistribution and income support, has tended to occur within a functioning democratic framework and in my view this is thanks to the previous point which we haven't seen major microeconomic and financial instability.

This has had an additional benefit in that the inflation targeting and flexible exchange frameworks which are key to maintain a modicum of monetary policy independence have mostly proven resilient and whereas rigid exchange rate arrangements that we have in some of the countries in the region have not and they've tended to shift back to more flexible regimes.

We did have inflationary pressures going up in 2014 and 2015 but this has mostly reflected the one off nature of the impact from ready price changes.

In the case of Chile and as I mentioned before, a long term inflation expectations have remained firmly at the 3% target in spite of this significant jump in inflation from the weakening of the exchange rate.

I think that the validation of this monetary framework in the presence of low interest rates globally today and low growth points towards what I expect will be a gradual dissipation of these inflationary pressures.

This is something that we are actually seeing today in private expectations. On the left, we have current unexpected inflation going forward. You see that very large increasing inflation driven by the weakening of the exchange rate and the falling commodity prices.

Here, monetary policy tightening across the region but then come forward, inflation starts to dissipate and monetary policy starts to move in a less tightening stance or a more supportive stance.

There's of course, a lot of variation depending on each country's circumstances. It is also noteworthy that within this framework of inflation targeting, an easing of monetary policy is not because we're concerned about the exchange rate or we are concerned about growth. These are legitimate concerns, of course.

But, simply because in a scenario such as this inflation going down and if monetary policy doesn't adjust then that inflation targeting will be undershot.

Finally, the prevalence of a risk scenario of slow growth, disinflation and an appreciated exchange rate which is some of the challenges that some advanced economies are facing could generate an important policy dilemma in case of the monetary toolkit was reaching its exhaustion. This is what we see in vast economies even financially stable ones.

Because of the high inflation we have endured, this is an hour of silver lining of having high inflation that we are fairly far away from a possibility of reaching the zero lower bound and exhausting the normal monetary policy instruments.

One argument that has been given that secular stagnation in open economies with zero lower bound tend to generate beggar thy neighbor effects. In Latin America that is unlikely to operate like that because precisely there is room for inflation to still go down and also the monetary policy to react being way above the zero lower bound.

Another risk scenario in this environment is what has been implied that zero interest rates and very expansionary monetary policies generate asset price inflation, excessive froth in the gray market. This is something also that is very far from what we might see in Latin America thanks to the tepid overall economic tone and the stability of commodity prices.

As we have known for a while, achieving macro and financial stability is not sufficient to successfully tackle the significant long term challenges Latin America still faces. I briefly touched on some of them.

But, I strongly think that by avoiding the major dislocations that results and that we have seen in the past from financial instability appears necessary to think about these long term challenges.

So far, this global environment of secular stagnation which has not been positive for growth or investment does have some supportive elements that keep helping Latin America at least in the short run.

With this, again, thanks to the Peterson for the invitation. And I'd be glad to take some questions that you may have.

Adam Posen: Thank you very much, Pablo. It's a treat if this is what you do when you have a chance to think longer term. I have a fellowship I can sell you. This was very stimulating and I appreciate it.

I'd like to put a couple of questions to you before we open it up to the floor if I could.

The first question in a sense goes back to the very secular stagnation concept. Whenever Summers or others who have worked on this say it's usually a question of something happening in the rich countries, in the frontier as we call it. There is no automaticity that secular stagnation in the rich countries necessarily translates to secular stagnation in the still converging countries beyond the obvious fact that the export markets are down.

I'm not saying you were suggesting that went together but there at least is some sense that one could imagine if the frontier economies are slowing down that beyond a little bit of export drag, it actually in some ways might be better for the converging economies because even more capital should run downhill, the ability to catch up is improved.

Could you say a little bit more about how -- are you thinking in terms of secular stagnation actually emerging Latin America or this is the spillover of secular stagnation in the US and Europe or how do you think about that?

Dr. Pablo Garcia: I think that the key element to look at secular stagnation and the implications for emerging economies, arise from the fact that not only demand for exports.

Not only the impact of growth on commodity demand or demand for exports but rather the linkage investment. So, what we are seeing for instance in Latin America is the slump in investment in natural resource industries and that has been one of the main drives on aggravated growth.

And one of the main facts, of course, domestic factors but one of the main facts behind this downgrade in investment is overall investment in the world.

So, I believe that that impact of low investment has direct linkage to growth capital recommendation in Latin America and in all emerging economies.

Now, if that was the only story, we would probably be seeing a much tougher time because interest rates would be higher in any case and then therefore we would be facing maybe some stop work or even larger capital outflows.

But, the fact that this is accompanied by this extra-loose monetary policy gets this silver lining that allows us to adjust more readily to this environment of lower growth.

Adam Posen: Very good. Thank you for the clarity. The second issue, and again, I don't want to get too far from your monetary policy remit but you made the comparison with the ASEAN and you mentioned a little bit about them being similar in various ways.

But, one thing which we've seen whether it's Indonesia or Chile or even for that matter Canada is well-managed economies that are commodity exporters seem to have a difficult time diversifying.

And our colleague, Colin Hendricks and Mark Nolan did a book for us of resource course, I'm not suggesting Chile or Canada have the resource course. In a sense, it's the opposite question. It's when you have a liberal democracy with price stability, with good institutions, with free markets. But, you don't see diversification.

What does that tell us? Do you view this as something that is just completely unamenable to policy? This is you lot in life? Chile will always be blessed and cursed by copper or will at some point decades of good economic management suddenly lead to something else in the economy? I mean, how should we think about this?

Dr. Pablo Garcia: Believe me, there's also a big debate in Chile.

Adam Posen: Yes, that's why I'm raising this.

Dr. Pablo Garcia: Especially, what the government should do or what the state can do to help diversification. At least my view is that if you take a look at what the structure of export was in the 60s when the economy was totally closed, 95% of exports were copper.

Today, it's around 50% even after the expansion in copper output has been drastic. So, there's been a lot of diversification over a period of 30 years.

Now, looking forward is maybe the question is whether we can become even more diversified. I want to say two things about that. One is, Chile is about 0.4% of global GDP and global population but we have 40% of global copper reserves.

So, the size of the economy is 100th of the size of the amount of copper we have. So, it's very hard to diversify away from that.

The second point is, maybe regarding the ASEAN economies, why were they able to diversify so much into manufacturing. The main argument one can make there is that manufacturing shifted to China where you had an abundance of labor. Transport costs were low in the region and therefore you had this hub.

Maybe if Latin America has followed as a region, a path of more openness and integration to the world, maybe Brazil could have played the role of becoming a global manufacturing hub and you would get this interconnections within the region. But, that didn't happen.

So, the two things I guess mattered. The relative abundance of natural resources versus low skill labor is much higher in Latin America than in Asia. And second, due to the lack of total commitment to open economy integration means that this manufacturing shift happened much more intensely in Asia than in Latin America.

Adam Posen: Very interesting. Thank you. One more question if I could before we open it up. You mentioned, this is something we debated in Chile, the diversification issue. Obviously, even those of us who are largely oblivious are aware of some of the controversies over the pension system and things like that.

Meanwhile, there is, as you've noted, a sort of generalized perception that Latin America is turning away from the left. Should we just be avoiding all kinds of generalizations about economic politics in Latin America or is there some kind of movement or commonalities that you want to point to?

Dr. Pablo Garcia: I think it's less of a political issue than the way we have been adjusting to this sense that commodity prices are way lower and we are realizing that fiscal constraints are tougher. And that, I think, is the main driver of what has been going on in the politics more than simply a shift towards more right or less left.

And it's interesting that this have been happening within fairly stable democratic processes which I think is a very important thing and makes it quite the difference regarding our not-so-recent history.

Adam Posen: Very helpful. Thank you. So, let me turn to the floor. We have a travelling mic up front in Jessica's hand. We have a standing mic in the back.

Why don't we let Jose have the pride of first question?

José De Gregorio: José De Gregorio. I have a question, following up the first Adam's point about secular stagnation in the world but with the Latin America a lot to catch up. So, in a way, one could think that it is a good thing secular stagnation because it's bringing very low cost of financing.

So, interest rates are very low. These economies have a lack of capital so you have a lot of opportunities to invest.

Now, you mentioned the problem is that there is no world-demand for output. So, it's not profitable to invest in export. So, perhaps one could think that now the prospect for catching has much more to do with domestic investment, let's say infrastructure and many other things that countries need.

Now, the problem of Latin America is that regulation, political capture is relatively weak so it's kind of difficult to push or in current circumstances to have a boom in domestic investment. So, I would like to know your views.

Dr. Pablo Garcia: I think that I agree that if secular stagnation was simply a matter of a downward shift in investments in advanced economies, it would mean that comparatively now, capital is more profitable in emerging economies in Latin America.

My sense is that the downshifting of investment is a global phenomenon. It's hard to think that that is going on only a certain part of the world. It's also going on in terms of commodity and investment is very clear.

You look at the fiscal formation in mining. It has fallen by several percent this point of GDP in Chile, in Australia, in Canada, as I showed in the figure this downshift has been going on all over the world.

So, I don't think that the demand for investment is going down only in advanced economies. I think it's a phenomenon that goes on globally.

Now, regarding the scope for fiscal expansion or infrastructure spending, maybe in 50 years, we'll realize that sustainable debt to GDP ratios are much higher than what we think today.

But, so far, there is a sense that we should stick to the -- or orthodoxy of having a sound fiscal and having fiscal rules and limited deficits and that I think also limits a lot the extent to which you can undertake large infrastructures and programs.

Adam Posen: Yes. So, the gentleman there and then Joe Marie and then Bill and then Jeromin.

Male Audience 1: Rahim [inaudible 0:44:05], the Federal Reserve. So, my question would be related to his. So, I guess the broader question is what do you see to be the scopes for structural reforms within a region given secular stagnation doesn't mean necessarily that the convergence process has to stop given differential in productivities and the level of technological advancement.

And it seemed like one way to do that might be internal structure reform that would help sort of continue that process and close the gap.

Dr. Pablo Garcia: That's a very good question. I think that one can view structural reforms in two areas. One, we thought that we had achieved but we see that it's never complete is sound macro. Autonomous central banks, flexible exchange rates, a readily open economy, we thought that that was a given. Now, we see that it's always a work in progress. And the question is not whether we can achieve it for the next few years but whether it's a scenario for the next two decades. So, that would be one main thing.

On the second, what are the second generation structural reforms? The difficulty there is we can agree on the headlines, better dedication, better infrastructure, sound governance. But once you get into the details, the political economy problems are very hard.

I think we have seen that in many countries in the region including Chile that people can subscribe to structural reforms that will improve the quality of human capita for instance.

But, once you try to design the institutions to achieve that is much harder. So, I would focus for now on maintaining financial and macroeconomic stability and keeping that for the longest time possible, hopefully for decades. That can achieve, I think, wonders in terms of convergence.

As we've seen, the main episodes of divergence in Latin America has been through the experience of large financial crisis. Let's just abode those for two decades or three decades and the countries will change totally.

It's very [inaudible 0:46:31] I think is very important.

Adam Posen: Thank you.

Jomarie Grace: Thank you. Jo Marie Griesgraber, New Rules for Global Finance. Let me just say that I'd like to pick up and push you a little bit on the last point and challenge you to look at the investment in education of the ASEAN countries especially China, Japan, Korea and so on.

Looking at your concern for investment and look at the real return on education and how it builds the capital base, the human capital of your country. And then, I'd like to throw in a second politically economy question which has historical roots.

What is the portion of the copper sales going to the military at this point? At the original change to civilian rule just yesterday, it feels like, there was pretty tight control by the military over the copper and I'm wondering how that has evolved.

Dr. Pablo Garcia: Thank you. I totally agree that educational investment is -- that demand is not suffering is not suffering from secular stagnation. So, the profits are very high.

My point was that achieving a social consensus on how to do it is extremely hard because it is not cheap. So, you need tax income. You need to change taxes to do it. How to do it in a way that raises enough and has little or limited welfare cost is a difficult balance.

And then, how to implement it in a way that reaps the highest benefits from increasing education in primary, secondary, tertiary education. That's also a very tough design process because of the different interest groups and the way people and families disagree on freedom of choice and integration on schools. Gratuity in college or not.

So, the implementation and the achievement of political concerns has proven to be much harder than simply subscribing to the idea that that's where you should put your resources. I wanted to highlight that point. I'm not saying that it doesn't matter but rather the politics are much harder than one might think in the first place.

Regarding the second point, so that the way the law works in this sense is that there is a 10% of the sales of the state owned copper company which represents around a third of total copper production, that goes to finance the military in terms of equipment.

However, there are two things that doesn't unhinge the budget because they have their subject to the same budgetary approval rate procedures that everybody else.

And that means that the big increase in copper prices in the previous slump or recent slump led to significant savings and they're being saved in a fund that is administered by the Central Bank. It's a strategic contingency fund.

There's been a number of discussions on how to change this. There seems to be political concerns to change it but does no agreement on to change it for what in terms of how should be the appropriations and the multi-year budgeting for the military. How you would structure that there has been ongoing debate on the issue.

Adam Posen: Thank you. Bill Cline.

Bill Cline: Bill Cline here at the Institute. I'd like to raise two elephants in one diagram. The first element is China. It seems to me that your storyline could be affected massively if China had been in a different trajectory in recent years.

China seems to have been the real driver in the commodity price boom and then the commodity price collapse. So, I think the key question for Latin America going forward is what is the growth model in an era in which maybe the great upward push from China is no longer there?

The second elephant is the political dysfunction in the element in economies of the region -- Brazil, Argentina, Venezuela, maybe not quite as the size of an elephant in that case.

But, if you were to just take you Latin aggregates and your charts and do it for Mexico, Peru, Colombia, Chile, I suspect it'd look a lot better. Then, the diagram question is, the monetary stimulus to the economy in ISLM is it's going to be more profitable to invest and it seems to me the big picture is that investment isn't responding much to lower interest rates.

You have a special story for where that would be the case in Latin America. A, it's distorted by the commodity demand in B, you seem to have a story that sounded like the banks not being able to make loans because the -- and that shrunk your upper arrow relative to the lower arrow.

But, I wonder if there's a more general problem of lack of the expected response of investment to lower interest rates even in the north. I wonder if you'd have any thoughts on those questions.

Dr. Pablo Garcia: Thank you. So, on the first point, I think that China is part of the story in terms of massive accumulation of capital and this shifting away from investment towards consumption and the overall rebalancing of the economy. And that's one argument why this secular stagnation story has global implications. China, I think is part of that story in terms of this mix of very high savings and reviews or limited investment.

Even though in the short term, there has been some stimulus over this year. The overall picture is I think in the same direction of shifting away from high investment to more consumption and individualization that means a lower real interest rates.

So, I don't see this as contradictory with the story in advanced economies.

It's true that if one is in Latin America, there seems to be a lot of political dysfunction but taking a bit of outside view, even if it's very hard, I'm not sure it has been that dysfunctional in the sense that the process has allowed political transitions that are more realistic in terms of the constraints that the countries face.

There are only a few exceptions, maybe Venezuela but I don't want to get into the specifics of that. But, in Argentina or in Brazil, there's been a transition towards the reality of tighter macro within a broadly democratic process. And I think that's good news.

Maybe the politics in the world are a bit out of whack. Compared to that, Latin America, I don't know if it's fairing too badly.

And in terms of reaction of monetary policy and the impact on investment, at least my view is that the fact that monetary policy can become looser as expectations indicate is mostly a sign that inflation has been kept under control even though the very sizable depreciations have had an impact.

And therefore, it's not necessarily the impact of lower monetary policy rates on investment which I think should be highlighted but rather the fact that inflation expectations have remained relatively anchored and therefore the scope for looser policy and in some way a cushioning effect of this lower growth and the avoidance of the typical pro-cyclical reaction of policy which meant that when the economy weaken, the exchange rate went up, you need to raise interest rates and everything ended up in a sudden stop and it would be financial crisis.

So, that process is not there and I think that that's a good news.

Adam Posen: Thank you very much. The gentleman at the back and then Jeremy.

Gonzalo Pastor: Hi, I'm Gonzalo Pastor from Peru. I have a question Pablo. Could you elaborate a little more about the risk to financial stability from the deceleration in growth in Latin America because you would expect that as the economies in general decelerate, you know the banks would under some stress, credit growth will not be as high. You will have an increase in non-performing loans.

On the other hand, you know you have a banking sector in Latin America with very high returns on equity. So, there has to be an impact probably, probably not, it's up to you to tell me if you see some risk to financial stability. Thank you very much.

Dr. Pablo Garcia: The fact that interest rates in the world have become really low I believe is the silver lining that allows the financial system and the economy as a whole to withstand the spirit of low growth for a while with limited scope for instability.

When taper tantrum occurred, you had this very large shift in long term interest rates and the concern that everything was going to end in tears in the very near term that monetary policy would increase in the US, term premium would widen, you would see massive devaluations in the region, maybe unhedged debt would become a problem and we would may end up with a sudden stop and a financial crisis.

So, the fact that doesn't happen I think is a good, again, is a good news.

In the short term also the significant deceleration in growth and in investment growth, particularly, has meant that corporate leverage was relatively high has stabilized and has been actually coming down.

The unintended benefit of the slowdown in growth that debt is not going up anymore. So, balance sheets are being slowly -- the deterioration are being sort of contained.

Now, no one ever knows. We need to be very aware of these types of issues and that's why Central Banks typically do stress testing. That's what we do in the Central Bank. We take credit risk, market risk, and we do a regular every six months stress test of the whole banking system to see this type of events.

Adam Posen: Great. Jeromin and this will be the last question.

Jeromin Zettelmeyer: Hi. Pablo, it's great to have you here. I'm sorry I'm a little bit. [inaudible 0:59:01] from the Institute. So, I wanted to push you a bit more on your answer to the first question by [inaudible 0:59:08].

So, basically, [inaudible 0:59:09] said something like now is a good time for Latin America to invest because you can get a capital cheaply and you responded well but the problem is we suffer from the same constraints to investment as everyone else.

If the private sector does it, there's no demand. If the public sector wants to do it, we lose macro stability.

So, just to push you a bit more on that. I still think there are some things that maybe on your power that you can do to get out of this dilemma. So, one is in Chile, your guys are the world champions of engineering clever fiscal rules. Truly the world champion.

So, I think one area where you are at the frontier you could innovate is going back into this very difficult tricky question of capital budgets and seeing if you can do this in a way that's credible.

If you could, you would do a true service to the world including to Europe because we sort of lost face in that but again we're not as good as engineering fiscal rules as you are. So, this is one thing. So, that might give you the scope of doing more on the fiscal front without losing a macro orthodoxy.

And then the other thing that comes to mind is what makes Latin America in generally I think the south unique right now is that the populism wave is receding and Latin America was increasing in the north. And so the question is, whether on the trade front, one can get some sort of coalition of the non-populist willing, if you like, to do more.

So, basically, to do more in a south-south basis, I mean, previous attempts of trade integration in Latin America has been pretty not that successful. Maybe this is a moment for a sort of new push on regional free trade agreements that just focuses on the south.

Adam Posen: Before you respond to that, I think great questions, I will also say that Jeromin would do a real service to the Institute in the world where he came up with some of these fiscal rules and things. That might be a good project now that you're here and you can co-author with our distinguished guest. I'd be fine with that.

Dr. Pablo Garcia: Let me first answer the second one. I didn't mention it but maybe that's because the risk is so high. If you have protectionism in the advanced world and protectionism in the US in particular, that's extremely bad news for everybody and there's no extent of south-south integration that can counterbalance that.

For Chile, protectionism would be a total disaster. I think that is very, very much of the case.

And one can expect that if there is a wave of protectionism in the advanced economies what would follow is protectionism everywhere else. It's kind of the fashionable thing to do -- follow the consensus in the advanced economies. The political pressures are always towards being more populist and if the well-behaved guys are doing nasty stuff then the lesser well-behaved will leverage on that. We're very concerned about it.

On fiscal rules, I think the very interesting characteristic of the Chile's fiscal rule is that it is very hard to get around it. So, it is so -- people argue that maybe it's not so transparent, that it's difficult to calculate but overall it's fairly straightforward.

The main feature it has is that you cannot go around it. So, if you want to have more public spending, that will have to be at the cost of piercing the rule. Of course, you can then say, “But we are going to invest in things that are profitable in the future.”

But, what do you record as income and expense over the line or below the line? Well, we have the IMF that tells us how to do it.

You cannot say we are going to invent our own accounting and then try to disguise expenses for future income and therefore being netted. So, I think that it's very critical to see this.

There has been two, maybe two particular ways of doing this. One is public private partnerships in infrastructure which is in some way contingency and delayed payments. Chile has been successful in that.

But, still you need to report whether the contingencies and the potential guarantees that are in the system that this has been reported. And the second is there's been currently a discussion on creating an infrastructure fund.

But, the infrastructure fund is created in such a way that it incorporates in its balance sheet the current assets of -- that had been managed by this private-public partnerships and therefore that ensures that it would continue to be managed in a responsible way going forward.

But, going through actual more spending without changing your target for the fiscal rule, there's really no way around it. And I think that's a strength of the rule but you cannot trick it in that very basic way.

Adam Posen: Terrific. Please join me in thanking Pablo Garcia Silva, Member of the Board of the Central Bank of Chile.