The bigness of smallness: The financial crisis, its contagion mechanisms and its effects in Latin America

This paper has two purposes. First, it seeks to explain the reason why a relatively small shock (in the subprime market in the United States) had a systemic effect on the world economy. It is argued that this responds to the combination of off balance sheet funding and pro-cyclical leverage management. Second, it analyses the transmission mechanisms and the possible effects of the crisis on Latin American economies. Past crises had generalized, deep and enduring effects across the region, and restricted access to external finance and the disruption of international trade turned out to be their main channels transmission. In spite of specificities, the current episode and its manifestations are not an exception to the pattern of previous crises. The final outcome will depend on the type of recovery that takes place in the developed world and on the effectiveness of the counter-cyclical policies applied in Latin America.