Friday, April 8, 2011

Rediscovering Prebisch

Yilmaz Akyüz has written a very good post on the boom and bust cycles in the periphery or the less developed countries, resulting from long-term capital inflows and outflows coming from the center or developed countries. He notes that we are entering a fourth cycle since the collapse of Bretton Woods. The basic mechanism can be described as follows, a crisis in the center, which leads to low rates of growth and interest rates, creates the conditions for inflows of capital into the periphery.

The inflows, in turn, lead to a boom in the periphery that goes hand-in-hand with currency appreciation, and in some cases greater indebtedness and asset and commodity price bubbles. The appreciation weakens the external position in the periphery, and eventually something (e.g. higher interest rates in the center, a fall in the price of commodities, etc.) triggers a reversal of capital flows and a crisis in the periphery.

It must be noted that the three previous cycles, to which Akyüz refers, can be also observed in the US economy. The cycles in the periphery have been associated in the US to three debt-led cycles in which the boom was associated to appreciation of the currency, and asset bubbles that allowed consumption to increase, in spite of the stagnation of wages. Arguably, it is the American boom and bust cycles that drive the flows of capital, and the cycles in the periphery. So Raúl Prebisch still has a lot to teach us on the interaction between the center and the periphery!

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