Comparing the Latin American and European Debt Crises

The European debt crisis may conjure up memories of the Latin American debt crisis of the 1980s. A recent article in The Regional Economist explored the similarities and differences between the two events.

Similarities

Economist Paulina Restrepo-Echavarria and Research Analyst Maria A. Arias, both with the Federal Reserve Bank of St. Louis, explained that both cases involved the respective regions experiencing rapidly growing output and saw capital inflows meant to finance investment instead finance consumption booms. And both cases also saw such growth come to an end due to external shocks.

In Latin America’s case, a hike in U.S. interest rates caused by an increase in oil prices triggered two issues that negatively impacted the region:

• Most Latin American countries were oil importers, so rising oil prices had a direct negative impact.
• This increase ushered in what is known as the Volcker era, in which then-Federal Reserve Chairman Paul Volcker raised interest rates sharply to control U.S. inflation. Latin American countries borrowed heavily from the U.S., so the interest rate increases made borrowing much more expensive.

Restrepo-Echavarria and Arias noted that these countries, rather than adjusting their borrowing and spending, saw debt increase from 30 percent of gross domestic product (GDP) on average in 1979 to nearly 50 percent for larger countries in 1982. The authors wrote, “This situation became unsustainable and ended up with Mexico’s default in 1982, followed soon by the default of other countries in the region.”

In peripheral Europe (meaning Greece, Spain, Portugal and Ireland in this case), the external shock was the Great Recession. Debt had risen from 90 percent of GDP on average in 2000 to around 200 percent in 2009. When the Great Recession occurred, capital flows reversed, and many of these countries defaulted.

Differences

The type of external shock wasn’t the only difference between the two situations. Restrepo-Echavarria and Arias noted that the composition of the debt, the interest rates the regions were facing and the relationships among the countries were also different.

Regarding debt, the types of debt were different for the two regions. Public debt drove the increase in total debt in Latin America, while private debt drove the increase in Europe.

The areas also had very different experiences with interest rates. During Latin America’s expansion, the area enjoyed low real interest rates, then experienced a sharp rise. In contrast, real interest rates in Europe were around 6 percent in 1998 and rose over the next few years before trending down throughout the 2000s and falling sharply during and after the Great Recession.

Results

In Latin America, the debt crisis resulted in a lost decade of anemic growth. Restrepo-Echavarria and Arias noted, “Currency devaluation, an emphasis on trade expansion and eventually debt restructuring through what was known as the Brady Plan helped the countries in the region regain strength and return to economic growth.”

Regarding the European countries, austerity measures and debt restructuring have been part of the response. Restrepo-Echavarria and Arias wrote that deeper integration by the European Union has moved to integrate even further by creating joint supervisory authorities and a closer fiscal union: “Ultimately, more unified coordination and governance could strengthen the fiscal union and lead to greater economic stability.”

Additional Resources

• Regional Economist: Sovereign Debt Crisis in Europe Recalls the Lost Decade in Latin America
• On the Economy: The Effect of Recent ECB Policy on Inflation Expectations
• On the Economy: Emerging Economies’ Vulnerability to Monetary Policy Changes