The Search for a Framework
Edited by Masahiro Kawai and Mario B. Lamberte
Chapter 4: Managing Large Capital Inflows: Taking Stock of International Experiences
Susan Schadler INTRODUCTION 4.1 Large capital flows to emerging markets are almost inevitable given the wide disparities between capital per worker in emerging and in advanced countries. When a combination of historical factors in emerging markets has prevented the investment and technological progress needed to catch up to industrial country income levels, removing such constraints on growth should result in a re-equilibrating shift in the global allocation of capital. This is the story since the early 1990s – and the result has been large changes in the global allocation of capital as the world moves from an old equilibrium toward a new one. Shifts to new equilibria seldom happen smoothly and can have many (desirable and undesirable) side-effects. This is the broad framework in which large capital flows should be seen. In the course of some 20 years’ experience with large capital inflows to emerging market countries, four broad perceptions seem to have taken shape. ● ● ● Episodes of large capital inflows carry two main risks: that they will feed overheating pressures which effectively undermine the benefits inflows should deliver and that they will end in crisis. There are no good macroeconomic policy solutions to the potential overheating problem. The orthodoxy is that restrictive fiscal policy is the most effective response, but it is difficult to implement.1 Much attention, therefore, focuses on monetary policy options. Some argue that policymakers must ultimately decide between currency appreciation and higher inflation. Others argue that sterilized intervention can guide economies on a low-inflation, low-appreciation path. Large inflows...
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