Latin American countries have wide-ranging experiences with economic policies and macroeconomic outcomes. The social and economic consequences have at times been adverse and dramatic. The Monetary and Fiscal History of Latin America project has produced systematic evidence using comparable datasets from these varied historical experiences to help build a knowledge base for the analysis of impacts of alternative monetary and fiscal policies.
The form of evidence in this study is distinct from the experimental types because it is problematic to run purposeful experiments on entire economies looking for aggregate or so-called “general equilibrium impacts.” The study of macroeconomic policy explores not only direct impacts on individual behavior but also indirect impacts that emerge through market price responses and even through responses of future policies to changes in current policies. These interactions in the economic arena are a critical element of policy analysis.
The need for a conceptual framework
While many have emphasized the importance of evidence-based policy, evidence seldom speaks for itself. It typically requires a conceptual framework for interpreting the evidence. Many decades ago, Tjalling Koopmans, while at the University of Chicago, wrote a thought-provoking essay entitled, “Measurement without Theory.” This reviewed the extensive research of Burns and Mitchell (1947) measuring business cycles from macroeconomic data. While respectful of the insightful empiricism of Burns and Mitchell, Koopmans pointed to the limits of such analyses when divorced from a theoretical lens to interpret the evidence in a fully meaningful way. The architects of the Monetary and Fiscal History project, Tim Kehoe, Juan Pablo Nicolini and Tom Sargent, are keenly aware of the interplay between evidence and theory and appropriately designed this venture to facilitate the use of multi-country data to compare and contrast alternative models of the fiscal and monetary interactions.
As a macroeconomist, I find this study to be particularly promising because of the varied institutional structures, policy experiences and macroeconomic outcomes. The countries of Latin America have different degrees of separation between the conduct of monetary and fiscal policies. This, of course, influences whether and to what extent monetary and fiscal policies dominate in practice and the extent to which the policies can be fully coordinated. Institutional “details” of this nature matter when exploring alternative models of macroeconomic impacts. Whether fiscal or monetary policies are dominant or the extent to which they act in unison with common ambitions potentially has important consequences for macroeconomic performance. Studies like this one help in our understanding of the impact of policy interactions.
Conceptually, the intertwining impact of monetary and fiscal policy sometimes leads to indeterminate outcomes or “multiple equilibria.” This creates a direct challenge for model builders, but it also offers potentially new sources of dynamic responses and variability in the evolution of the macroeconomic outcomes. The source of this dynamic variation is that economies can be pulled in different directions at different points in time. Finally, a point that is often underappreciated is that people inside the models economists build, such as consumers, entrepreneurs and even policy makers, are exposed to macroeconomic ambiguity as they wrestle with uncertain policy impacts and evolution.
Dynamic equilibrium analyses of economies are vital for understanding how macroeconomic policies operate. This makes macroeconomic policy analysis difficult, but the results can be potent. While data and analyses from this project will not resolve all of the modeling and measurement challenges, the authors and architects of the study have taken an important step in enhancing our understanding of macroeconomic policy.
Editors Note: Lars Peter Hansen will be speaking on Confronting Economic Uncertainty: Implications for Markets and Policy at the IDB on Sept 24 at 11:15 a.m. Those interested in attending his lecture may register here. The lecture is part of a larger conference on the monetary and fiscal history of Latin America.