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Gustavo Adler and Mr. Sebastian Sosa
Highly favorable external conditions have helped Latin America strengthen its economic fundamentals over the last decade. But, has the region built enough buffers to guard itself from a weakening of the external environment? This paper addresses this question by developing a simple framework that integrates econometric estimates of the effect of global factors on key domestic variables that determine public and external debt dynamics, with the IMF‘s standard debt sustainability framework. Results suggest that, while some countries in the region are well placed to withstand moderate or even large shocks, many would benefit from having stronger buffers to be in a position to deploy countercyclical policies, especially under tail events. External sustainability, on the other hand, does not appear to be a source of concern for most countries.
Mr. Kei Kawakami and Rafael Romeu
A stochastic debt forecasting framework is presented where projected debt distributions reflect both the joint realization of the fiscal policy reaction to contemporaneous stochastic macroeconomic projections, and also the second-round effects of fiscal policy on macroeconomic projections. The forecasting framework thus reflects the impact of the primary balance on the forecast of macro aggregates. Previously-developed forecasting algorithms that do not incorporate these second-round effects are shown to have systematic forecast errors. Evidence suggests that the second-round effects have statistically and economically significant impacts on the direction and dispersion of the debt-to-GDP forecasts. For example, a positive structural primary balance shock lowers the domestic real interest rate, in turn raising GDP and lowering the median debt-to-GDP projection by an additional 10 percent of GDP in the medium term relative to prior forecasting algorithms. In addition, the framework employs a new long-term (five decade) data base and accounts for parameter uncertainty, and for potentially non-normally distributed shocks.
Mr. Sohrab Rafiq

interpreted as a real activity factor, an inflation dynamic factor, a credit cycle factor and an asset price factor. 4 The unobserved factors ( F t i ) and factor loadings ( Γ t i ) are estimated as in Del Negro and Otrok (2008). The factor loadings in the measurement equation (2) are assumed to evolve according to the law of motion equation Γ t i = Γ t − 1 i + ξ t ( 3 ) This assumed structure is an efficient way of introducing non-linear (time

Mr. Kei Kawakami and Rafael Romeu

I. I ntroduction This study proposes a stochastic debt forecasting framework that identifies and estimates the impact of feedback between fiscal policy and macroeconomic projections – effects which are largely absent from current debt forecasting algorithms. In such algorithms, a distribution of fiscal and debt forecasts is projected by combining simulated macroeconomic scenarios, a fiscal policy reaction function, and a debt motion equation. In the proposed framework, fiscal projections reflect contemporaneous macroeconomic shocks through automatic

Mr. Sohrab Rafiq
This paper looks at the effects of a China slowdown on Emerging Market Economies (Indonesia, Malaysia, and Thailand) and Frontier Developing Economies (Cambodia, Lao P.D.R., and Vietnam) in ASEAN. The main finding is that the impact of China growth shocks on ASEAN has risen since the global financial crisis. A one percent decline in China’s growth implies a 0.3 percent reduction in growth for ASEAN EMEs and 0.2 for FDEs. An important component of inflation is also shared between ASEAN and China. These magnitudes are double what they were two decades ago due to stronger trade and financial linkages. Finally, a slowdown in China, while having real effects, also has a financial impact via slower credit growth and lower equity prices. This is in line with the existence of both portfolio balance and signaling channels, in which ASEAN market participants absorb news on China economic activity as an indicator over domestic growth prospects.
International Monetary Fund. Western Hemisphere Dept.

-American Development Bank (2008) ; Izquierdo and others (2008) ; and Osterholm and Zettelmeyer (2008) . 8 As in standard debt sustainability analysis, the focus of our analysis is the dynamics of gross debt and primary balance. Risks related to financing needs as well as the composition of creditors are beyond the scope of our work. 9 The VAR model (together with the spread equation) and the debt motion equations capture the key linkages between domestic and external variables. To fully determine the dynamics of debt ratios, however, a few assumptions are

Mr. Sohrab Rafiq

realized inflation (π t−1 ), the output gap ( y t−1 ), the nominal effective exchange rate (e t ) and a one year forward measure of inflation expectations based on Consensus Forecast survey data (E t (π t+1 )). Economic activity (y t ) is measured as industrial production. 5 To capture changes in policy objectives across time the regression coefficients are assumed to evolve according to the following law of motion equation β t = β t − 1 + v t where v t

Mr. Sohrab Rafiq

preferable than assuming discrete breaks, since changes to private sector expectations tend to be smooth due to aggregation. The presence of learning by agents also favors ‘smooth and continuous drifting coefficients’ over a model with discrete breaks. The use of a non-constant parameter model follows recent term structure models, which incorporate the idea that investors learn slowly about structural change. 10 The coefficients in (1) are therefore assumed to evolve according to the following law of motion equation: β t = β t

Alejandro Hajdenberg and Rafael Romeu

function to produce first a projection of the primary surplus, and then a debt-to-GDP ratio from the debt motion equation. Frequency distributions for public debt, as well as for all the other forecasted variables are obtained by simulating 1,000 stochastic paths. Figure 5 shows three fan charts with five-year debt forecasts for Uruguay under endogenous fiscal policy. The median projection is represented by the bold line. The first four shaded surfaces at each side of the median represent an interval of 10 percent of the distribution of the debt ratio, and the last

Mr. Sohrab Rafiq
This paper explores how monetary policy affects the real economy and its efficacy in promoting financial stability in a large low income country. This paper shows that monetary policy modestly impacts real economic activity and inflation via the bank lending and financial accelerator channels. Second, money market and treasury rates signal changes in the policy stance, while altering banks’ intermediation cost curves due to shifting risk premia. At the same time, evidence points to monetary policy inducing an overshooting in asset prices. These findings suggest that financial stability could be undermined if the calibration of monetary policy is based solely on output and inflation without accounting for the stage of the financial cycle. Finally, the paper discusses policy measures that would enhance the transmission of monetary policy and promote financial stability in Bangladesh.