Fiscal Rules, Monetary Rules and External Shocks in a Primary-Export Economy: A Model for Latin America and the Caribbean

The macroeconomic performance of Latin America and the Caribbean (LAC) is closely linked to the evolution of the world economy. The lost decade of the eighties cannot be explained by abstracting it from the deterioration in the terms of trade and the rising interest rates in the developed world that occurred during that period. Nor can the golden decade of 2002 to 2011 be understood without considering the significant improvement in the terms of trade and the considerable reduction in international interest rates. Finally, it is not possible to understand the slowdown in economic growth in LAC since 2011 by ignoring the deterioration of the region's terms of trade and rising global interest rates. This article discusses the connections to the global economy of a small, open, primaryexport economy dependent on external financing, where monetary policy operates under an inflation-targeting scheme; the reference rate for interbank markets is a policy instrument; and fiscal policy works by imposing a limit on the fiscal deficit as a percentage of GDP. The model allows us to evaluate the effects of changes in the prices of export commodities and global interest rates, as well as the impact of monetary and fiscal policies on output, price level, exchange rate, and the domestic interest rate.