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WP/11/245 Improving the Monetary Policy Frameworks in Central America Stephanie Medina Ca's, Alejandro Carr in-Men new, Florencia Frantischek 2011 International Monetary Fund WP/11/245 IMF Working

This paper examines whether the United States has effectively implemented the monetary policy frameworks in three of Central America's four countries that it has financial agreements with. This will assist those governments in setting their own fiscal paths and will help ensure that international monetary arrangements do not impede the pursuit of sound economic policies. Keywords: Central America, Macroeconomic indicators, Economic policies I. Introduction Central American leaders frequently warn that their economies are experiencing imbalances and can no longer sustain growth unless the United States makes a meaningful contribution to regional development. Since 1990, Central America has suffered from severe economic instability triggered by a number of factors. In addition to political and security issues, the economies of Central America have also been affected by the aftermath of the 1973 oil embargo. Central America's economies are heavily dependent on the US economy and are therefore not immune to economic shocks in turn affecting other parts of the world. In the late 1980s, for example, the oil shocks resulted in a severe recession in Mexico and other countries of Latin America. The result was that these nations lost many of their foreign exchange reserves and therefore could not support their economies. The effects of fiscal and monetary policies in Central America have also been affected by external shocks. The most famous are the effects of the US default on foreign debt in 1989. According to the official narrative, in the years that followed, the US economy recovered and the Central governments embarked on a period of economic recovery. However, evidence suggests that this was not the case. Since 1989, these governments have experienced deep recessions and continued growth difficulties. In the early 1990s, many countries of Central America experienced an explosion in imports of goods from North America, as a result of NAFTA. As a result, the Mexican peso declined in value by more than 40 percent and the Central American government's debt to GDP ratio increased greatly, which made it impossible for it to sustain growth (Bruno, et al. 2009). Over the past decade, these changes in the economic environment have caused many governments at all levels to lose confidence in their governments' capacity to manage the economy, to manage the financial markets, or to implement reforms.2 As a result, they have turned to the IMF for financial assistance. As we have recently discussed, the IMF has made a strong economic argument for supporting Central America in achieving the necessary economic reforms and promoting fiscal discipline.3 We have also discussed that the financial condition of Central America is not conducive to strong growth.

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