How might CAFTA change macroeconomic fluctuations in Central America?: Lessons from NAFTA

Abstract

This paper examines the potential impact of the Central America Free Trade Agreement (CAFTA) on macroeconomic fluctuations in Central America in light of Mexico's NAFTA experience. CAFTA and NAFTA share a number of common characteristics as both agreements envisage comprehensive tariff reductions, cover a broad spectrum of sectors, and include provisions about settlement of disputes. NAFTA helped spur a dramatic increase in trade and financial flows between the member countries and was associated with significant changes in the Mexican business cycles. The findings in this paper suggest that CAFTA could also result in similar effects. In particular, CAFTA could boost trade and financial flows between the United States and the Central American countries. The agreement also could play a major role in reducing the volatility of business cycle fluctuations in the region and could lead to an increase in the degree of co-movement of business cycles in the Central American economies and the United States.