By Hernando Vargas Herrera

Editor’s Note: Starting with this article, Dialogo a Fondo will have occasional contributions from guest authors. The aim is to broaden the range of views, experiences and academic research on issues relevant to Latin America and the Caribbean. The opinions in this article are exclusively the author’s and don’t reflect the views of the IMF, its staff or Executive Board.

Among the COVID-19 crisis unique aspects, one worth highlighting is how widespread it is. Unlike most events with economic consequences, it was a hard blow to advanced and emerging countries alike; its demand and supply consequences affected both financial markets and the real economy, and global trade. This unique combination disturbed our ability to forecast the future path of growth, inflation, unemployment, debt and other macroeconomic ‘vital signs.’ We wondered whether models and tools that work well in normal circumstances were fully capturing the enormity of what has been happening, and concluded they needed to be updated. Imagine doctors having to replace important equipment in the middle of a complex surgery. We made some important progress in this regard, and a key element for success was close cooperation with the IMF’s capacity development experts.

COVID-19 has caused significant economic damage to Colombia. Mobility restrictions led to a total or partial closure of whole sectors of the economy. GDP fell by 15.5 percent in the second quarter (compared to the previous year); unemployment jumped 8 percentage points between February and July. Oil prices and demand for our exports plummeted.

The government reacted quickly, with ambitious transfer and subsidy programs to support people’s income and employment, in addition to other resources directed at confronting the pandemic. Banco de la República, the Colombian central bank, adopted swift measures to stabilize financial markets, provide credit and ensure payments systems continued to work. The policy interest rate has been cut by 250 basis points since March.

A shock like no other

This economic shock challenged some technical aspects of how the central bank and finance ministry produce analyses and forecasts that will guide macroeconomic policies.

Economists typically study the past to try to understand the present and foresee the future. For example, studying how oil price fluctuations affect output allows us to identify certain patterns. That gives us an idea of what may happen the next time such fluctuations happen again. Researchers work hard to try to understand these connections and develop models to predict future developments. The more data we study, the more we can model different possibilities.

But if the shock is something that did not happen before, the models may not be able to capture them adequately and provide precise guidance.

This happened during the pandemic in ways that challenged monetary policymaking. For example, our inflation targeting strategy relies both on financial markets to transmit monetary policy actions to the economy and on forward-looking analyses to understand how these policies work over time. But during the crisis, the impact on supply and demand were different from what we have seen before. Economic and financial agents were not necessarily behaving as we in the central bank expected them to. Moreover, uncertainty about the pandemic’s future makes it very difficult to assess how today’s decisions will impact future outcomes.

The necessary response to the health and economic crises changed many macroeconomic guidelines and assumptions. Because of the strong revenue contraction, and to mobilize resources for health services and economic support for people, the government suspended its fiscal rule for 2020 and 2021. Public debt is expected to increase significantly, so future fiscal policy will have to be tighter than previously assumed to guarantee that the government’s medium-term fiscal targets are achieved.

So, it was a fortunate coincidence that before the crisis hit, we had already started to revamp our models to better articulate monetary and fiscal policies, a project originally undertaken to incorporate key developments like large immigration flows from Venezuela and important fiscal reforms. Support from the IMF’s Institute for Capacity Development was crucial to these efforts, especially after the pandemic began.

Teams from the central bank and the finance ministry worked together with IMF experts in two main areas: estimating the pandemic’s short-term impact, and enhancing medium- and long-term forecasting models. For the short-term, the Fund helped us improve sectoral analyses using a methodology that combines three elements: the events themselves (for example, a mandatory lockdown); their severity; and their persistence.

For the longer-term analysis, we developed together a new general equilibrium model tailored for the characteristics of a small oil-exporting economy like Colombia’s, calibrated with our specific fiscal targets. It was named COFFEE – Colombian Framework for Fiscal Economics and Evaluation model.

This work complements revisions to the inflation targeting regime operation and communications strategy implemented by the central bank some years ago. In addition, we have developed ‘Nowcast’ processes (real-time activity indicators) and use satellite information to help understand specific real economy developments. 

The strong measures adopted to fight the pandemic, combined with our country’s solid underlying economic fundamentals, allowed us to smooth the crisis’ damaging impact. The same way a healthy person has a better chance to recover quickly from COVID-19, our economy has fought its ‘inflammation’ successfully so far and is expected to regain its footing. No doubt, there is a long way ahead, which in part hinges on the recovery of our regional and global trading partners, but fundamentally depends on us maintaining good fundamentals. Measuring our macroeconomic vital signs precisely is essential for the accuracy of forecasts and to ensure we continue understanding how the Colombian economy is functioning.

Join the CD Talk on October 21, to learn more about the experience of Colombia’s Central Bank and Ministry of Finance in adjusting their macroeconomic framework during the crisis.

Hernando Vargas is the Technical Deputy Governor of the Central Bank of Colombia. He holds a Ph.D. in Economics from the University of Illinois at Urbana- Champaign. He joined the Central Bank in 1994 and worked as a researcher and Head of Research prior to becoming Technical Deputy Governor. He has written on the transmission of monetary policy in Colombia, the use of reserved requirements in an inflation targeting regime, the macroeconomic effects of fiscal reforms and exchange rate intervention in Colombia and on political economy issues pertaining monetary policy. Mr. Vargas has taught courses on Microeconomics, Macroeconomics and Monetary Policy at several universities in Colombia.