## Executive Summary

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---

### Exceptional external conditions: a double tailwind
- Two simultaneous favorable external developments for Latin America (LA):
  - A Global Liquidity Flood: persistently very low interest rates in advanced economies (AEs) combined with investors’ higher risk tolerance produce unusually easy foreign financing and large capital inflows; these conditions "will continue for some time, but could revert hastily once AEs’ recovery gains footing."
  - A Terms of Trade Bonanza: sustained high commodity prices—driven by demand from systemic emerging markets (EMs), especially Asian EMs—have raised LA real income and terms of trade.
- Drivers and features of the liquidity flood:
  - Low policy interest rates in AEs linked to sluggish recoveries, balance-sheet repair needs, and political constraints on fiscal policy.
  - Global risk appetite recovery reflected in "sovereign spreads near their record low levels of early 2007."
  - Some systemic EMs limit external adjustment via capital account restrictions and exchange rate intervention, diverting inflows to more open, flexible countries such as many in LA.
- Commodity price dynamics:
  - In China the intensity of use of some commodities—especially metals—per unit of GDP is "exceptionally high," so that China accounts for as much as "40 percent" of global demand.
  - High commodity prices have direct positive impacts on LA terms of trade and are partly persistent but uncertain in duration; supply responses will take considerable time.

### Key concerns and vulnerabilities for Latin America
- The unusual intensity of the double tailwinds can mask fragilities and foster complacency and exuberance, creating risks of boom-bust dynamics.
- Two distinct albeit related critical risks:
  - Large external current account deficits: LA historically has external current accounts that are "in deficit" and can "rapidly move to vulnerable positions" as domestic demand reacts exuberantly to easy financing and strong terms of trade.
  - Excess domestic financial intermediation: the financial sector can amplify credit and asset bubbles and exacerbate problems when inflows reverse or terms of trade decline.
- Interaction and amplification:
  - Financial vulnerabilities and excess current account deficits "interact and reinforce each other, compounding the difficulties" when tailwinds reverse.
- Regional structural features increasing vulnerability:
  - Open capital accounts and generally flexible exchange rate regimes.
  - Many LA countries already have current account deficits, unlike several Asian EMs with surpluses and less exchange rate flexibility.
  - Lower levels of public debt in LA make the region an attractive destination for inflows and potentially raise perceptions of implicit government guarantees.

### Magnitude and asymmetry of global rebalancing pressures
- In a multi-speed recovery, capital should flow from cyclically lagging to leading countries, but current global circumstances amplify this:
  - Advanced economies’ constrained policy mix and persistent monetary stimulus create stronger push factors for capital flows.
  - Some systemic EMs outside LA have prevented exchange rate appreciation and maintained current account surpluses, increasing inflow pressure on open, flexible economies in LA.
- Illustration of rebalancing asymmetry:
  - If the U.S. current account deficit narrowed by "2 percentage points of U.S. GDP" and the adjustment were borne entirely by Latin America, then the region’s current account deficit would have to widen by "the equivalent of more than 6 percentage points of Latin America’s GDP."

### Why easy foreign financing and high terms of trade pose policy challenges now
- Potential benefits:
  - Financing investment and consumption, and improving balance sheet resilience through debt management.
  - Some degree of permanent appreciation and current account widening is an expected part of equilibrium adjustment.
- Risks from intensity and transitory components:
  - The transitory nature of parts of the tailwinds increases the chance of "substantial vulnerabilities and heightened risks of setbacks."
  - High commodity prices spur domestic absorption booms, enlarge government revenues, and appreciate the real exchange rate—effects similar to large capital inflows.
- Comparative advantages and differences from other EMs:
  - Many LA economies have improved frameworks (greater exchange rate flexibility, inflation targeting, better bank supervision, reduced public debt), which mitigate but do not eliminate risks.
  - LA differs from some Asian EMs by being more open, more flexible in exchange rates, and more often in current account deficit positions.

### Policy response: objectives and instruments
- Overarching goal: contain the risk of boom-bust cycles while allowing necessary equilibrium adjustments.
- Exchange rate policy:
  - Flexible exchange rates should play a key role in dampening incentives for capital inflows and currency mismatches while allowing warranted equilibrium appreciations.
  - Foreign exchange intervention should "avoid playing an early role and resisting fundamental shifts."
- Fiscal policy:
  - Fiscal policy needs at least to be acyclical, "undoing recent stimuli and saving temporary revenue gains."
- Macroprudential policy:
  - "Always-desirable macroprudential policies should continue being developed and intensified," with focus on segments prone to bubbles to contain financial vulnerabilities and reduce credit procyclicality.
- Capital account restrictions:
  - In the current exceptional global setting, the temporary use of capital account restrictions on macroeconomic stability grounds "could be considered" to avoid excessive risk from large current account deficits.
  - Caveat: adjustments in macroeconomic policies are "a key first priority," and restrictions should not be used to substitute for such adjustments.
  - When temporary and not substituting for core macro adjustments, such restrictions "can be viewed as a prudent move to prevent boom-busts, thereby contributing to global financial stability."

### Structure of the note
- The note examines:
  - The unusual aspects of the current external environment conducive to strong capital inflows to LA (Section II).
  - Why today's easy foreign financing conditions are a concern for the region (Section III).
  - How Latin America should build its policy response (Section IV).

### Box 1 — How Do Low Foreign Interest Rates and Capital Flows Affect the Macroeconomy?
- Basic transmission:
  - Low foreign interest rates → capital inflows to an EM economy → FX supply increases → EM currency appreciates (if policymakers allow appreciation).
  - Appreciation reduces competitiveness via expenditure-switching: export volumes fall and domestic demand shifts toward cheaper imports → net exports decline → aggregate demand and GDP decline.
  - EM policymakers can buy foreign exchange to resist appreciation, converting a larger current account deficit into accumulation of reserves; sterilization can be used to avoid inflationary effects from reserve accumulation.
- Important qualification:
  - Low foreign interest rates also stimulate domestic demand directly, which can raise GDP and inflation—capital inflows are not inherently contractionary.
- FX intervention dynamics:
  - Intervention sustains incentives for capital inflows and can lead to more inflows, strengthening the stimulus on domestic demand and weakening the current account; overall effect on the current account is unclear.
  - Sterilized intervention may need to occur at an accelerating pace to hold the nominal exchange rate to an objective.
  - Sterilization is unlikely to prevent the decline in effective borrowing costs for many domestic agents; sterilized intervention will not fully offset the domestic demand boost from lower foreign rates.
- Main risks for LA:
  - Overheating and demand-driven current account deterioration rather than recession.
  - Large external current account deficits are a critical vulnerability; the initial size of the current account deficit is a robust predictor of the likelihood of rapid reversals.
  - Financial sector amplification: excessive risk taking, corporate bypassing of domestic prudential buffers, over-leveraging, and currency/maturity mismatches can produce a "double whammy" combining financial distress and current account reversal.
- Commodity exporter nuance:
  - Commodity export volumes are likely to be maintained under appreciation because world prices are set in foreign currency and exporters are price takers; appreciation driving prices below marginal costs is judged unlikely given currently high global commodity prices.
- Policy recommendations — overarching principles:
  - Use many policy margins as warranted by country circumstances; priority is to set macroeconomic policies right.
  - Fiscal policy should shift away from expansionary bias; saving temporary fiscal revenues is paramount.
  - Capital account restrictions can be considered in some cases but cannot substitute for macroeconomic adjustments; use them for macroeconomic stability to avoid excessive current account deficits rather than to target the exchange rate.
  - Policy success should not be judged solely by the level of the exchange rate.

- A. Macroeconomic (fiscal and monetary) policy guidance
  - Fiscal policy:
    - At a minimum, avoid procyclical fiscal policy—do not spend cyclical/temporary revenue gains.
    - Treat revenue growth in excess of growth of potential output (prudently estimated) as temporary unless attributable to lasting tax changes.
    - Be cautious about spending revenue gains driven by high commodity prices; consider saving temporary gains, investing abroad, or reducing debt depending on public debt structure and liquidity needs.
    - Consider active consolidation of the structural fiscal position where public debt is elevated or other structural concerns exist; current conditions offer an opportunity to accelerate consolidation.
    - Fiscal consolidation is unlikely to markedly raise capital inflows in LA given already high investor confidence and low spreads.
  - Monetary policy:
    - Avoid over-reliance on monetary policy tightening to counter inflows, since higher policy rates attract carry-trade inflows; monetary policy should be coordinated with fiscal stance.

- B. Exchange rate policy and FX intervention
  - Accept that real exchange rate appreciation is likely and can be cyclical and useful as a safety valve to relieve domestic demand pressures.
  - Exchange rate flexibility:
    - Substantial nominal flexibility, including appreciation, helps limit capital inflows and deters currency mismatches by making exchange rate risks apparent.
    - Cross-country evidence links greater nominal flexibility to smaller booms in domestic demand and milder contractions when global financing tightens.
  - FX intervention:
    - Sterilized intervention has unclear effectiveness on the nominal exchange rate and involves sterilization costs; resisting nominal appreciation can increase GDP volatility and deepen post-boom contractions.
    - Intervention is more defensible once the currency is clearly on the strong side, to break reinforcing cycles of animal spirits, capital/credit flows, and asset prices.
    - Intervention design principles: avoid fixed target prices, focus on amounts to be bought, consider announced end dates, and protect exchange rate flexibility.
    - With generally comfortable reserve buffers in LA, intervention decisions should be judged against net inflow size and current account deficits; countries with high deposit dollarization may consider some leaning to reduce future depreciation risks, mindful that intervention can slow de-dollarization.

- C. Macroprudential (MaP) and microprudential (MiP) policies
  - Strengthen MiP and deploy MaP to enhance financial resilience and reduce procyclicality (address maturity and currency mismatches, risk-taking, and softening lending standards).
  - MaP should:
    - Include targeted instruments and broad oversight; tailor tools to sectors (e.g., reserve requirements, dynamic provisioning, loan-to-value limits).
    - Address funding risks and incorporate borrower-level currency mismatch risk into regulations where relevant.
    - Encompass the entire financial spectrum, including shadow banking and corporate balance sheets.
    - Be implemented with clear institutional mandates, transparency, and coordination.
    - Recognize MaP is not a substitute for sound fiscal, monetary, and exchange rate policies; in cases where inflows bypass the banking system, MaP may be insufficient alone.

- D. Capital account restrictions — conditional, temporary, and targeted use
  - Principles for use:
    - Temporary and limited to extraordinary circumstances where external current account deficits risk becoming clearly unsustainable.
    - Not a substitute for macroeconomic adjustments or MaP strengthening.
    - Aim to prevent excessive growth of absorption and widening of deficits; focus on underlying current accounts (strip cyclical components and temporary terms-of-trade effects).
    - Designed to raise domestic interest rates and contain private demand growth when other policies are insufficient or too slow.
  - Design considerations:
    - Account for degree of capital market integration, institutional capacity, and whether restrictions represent a regime change with collateral costs.
    - Apply broadly across instruments and sectors (including FDI where necessary) to reduce circumvention channels.
    - Effectiveness evidence: controls can affect composition of inflows; evidence on total volume effects is mixed and tends to show diminished effectiveness over time as circumvention develops.

- Concluding guidance for Latin America
  - Recommended policy mix:
    - Allow flexible exchange rate regimes to play cyclical and defensive roles against easy foreign financing;
    - Pursue fiscal policies that are at least acyclical and save temporary revenues;
    - Proactively strengthen microprudential frameworks and introduce/use macroprudential policies to shield the financial sector and reduce procyclicality;
    - Use temporary capital account restrictions in some circumstances to avoid excessive risk from large current account deficits, as a defensive move to preserve macroeconomic stability.
  - Implementation reality:
    - Policy response likely needs to advance on multiple fronts at varying speeds due to implementation constraints and lags; capital account restrictions should not replace essential macroeconomic and macroprudential adjustments.

*Source: _sdn1107 - Executive Summary and Box 1 (IMF PDF)*

### Executive Summary ......................................................................................................

### Executive Summary

### I. Introduction
- Section listed: "I. Introduction" (page 5)

### II. A Global Liquidity Flood and Terms of Trade Bonanza for Latin America
- Section listed: "II. A Global Liquidity Flood and Terms of Trade Bonanza for Latin America" (page 7)
- Associated figures:
  - Figure 2. Capital Inflows and Global Financial Conditions (figure title as listed: "Global Financial Conditions and Capital Inflows") (Figure 2)
  - Figure 4. Commodity Prices and Terms of Trade in Latin America (Figure 4)
  - Figure 5. Domestic Demand and External Financing Conditions (Figure 5)

### III. Why Is Today’s Easy Foreign Money a Concern for Latin America?
- Section listed: "III. Why Is Today’s Easy Foreign Money a Concern for Latin America?" (page 11)
- Associated materials:
  - Box 1. How Do Low Foreign Interest Rates and Capital Flows Affect the Macroeconomy? (Box 1)
  - Figure 3. Current Accounts and Exchange Rates in Latin America and Asia (Figure 3)

### IV. How Should Latin America Build Its Policy Response?
- Section listed: "IV. How Should Latin America Build Its Policy Response?" (page 17)
- Subsections listed:
  - A. Macroeconomic Policies (page 19)
  - B. Exchange Rate Policies and Exchange Market Intervention (page 21)
  - C. Macroprudential Policies (page 24)
  - D. Capital Account Restrictions (page 25)
- Relevant figure:
  - Figure 6. A Snapshot of the Literature on Effects of “Dutch Disease” (Figure 6)
  - Figure 7. Domestic Demand Booms and Exchange Rate Flexibility (Figure 7)

### V. Concluding Remarks
- Section listed: "V. Concluding Remarks" (page 27)

### References and Front/Back Matter
- References section listed (page 28)
- Front matter indicates the Executive Summary begins on page 4

*Source: _sdn1107 - Executive Summary (IMF PDF) — table of contents and figures listing as provided.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Exceptional external conditions: a double tailwind
- Two simultaneous favorable external developments for Latin America (LA):
  - A Global Liquidity Flood: persistently very low interest rates in advanced economies (AEs) combined with investors’ higher risk tolerance produce unusually easy foreign financing and large capital inflows; these conditions "will continue for some time, but could revert hastily once AEs’ recovery gains footing."
  - A Terms of Trade Bonanza: sustained high commodity prices—driven by demand from systemic emerging markets (EMs), especially Asian EMs—have raised LA real income and terms of trade.
- Drivers and features of the liquidity flood:
  - Low policy interest rates in AEs are linked to sluggish recoveries, balance-sheet repair needs, and political constraints on fiscal policy.
  - Global risk appetite recovery is reflected in "sovereign spreads near their record low levels of early 2007."
  - Some systemic EMs limit external adjustment via capital account restrictions and exchange rate intervention, diverting inflows to more open, flexible countries such as many in LA.
- Commodity price dynamics:
  - In China the intensity of use of some commodities—especially metals—per unit of GDP is "exceptionally high," so that China accounts for as much as "40 percent" of global demand.
  - High commodity prices have direct positive impacts on LA terms of trade and are partly persistent but uncertain in duration; supply responses will take considerable time.

### Key concerns and vulnerabilities for Latin America
- The unusual intensity of the double tailwinds can mask fragilities and foster complacency and exuberance, creating risks of boom-bust dynamics.
- Two distinct albeit related critical risks:
  - Large external current account deficits: LA historically has external current accounts that are "in deficit" and can "rapidly move to vulnerable positions" as domestic demand reacts exuberantly to easy financing and strong terms of trade.
  - Excess domestic financial intermediation: the financial sector can amplify credit and asset bubbles and exacerbate problems when inflows reverse or terms of trade decline.
- Interaction and amplification:
  - Financial vulnerabilities and excess current account deficits "interact and reinforce each other, compounding the difficulties" when tailwinds reverse.
- Regional structural features increasing vulnerability:
  - Open capital accounts and generally flexible exchange rate regimes.
  - Many LA countries already have current account deficits, unlike several Asian EMs with surpluses and less exchange rate flexibility.
  - Lower levels of public debt in LA make the region an attractive destination for inflows and potentially raise perceptions of implicit government guarantees.

### Magnitude and asymmetry of global rebalancing pressures
- In a multi-speed recovery, capital should flow from cyclically lagging to leading countries, but current global circumstances amplify this:
  - Advanced economies’ constrained policy mix and persistent monetary stimulus create stronger push factors for capital flows.
  - Some systemic EMs outside LA have prevented exchange rate appreciation and maintained current account surpluses, increasing inflow pressure on open, flexible economies in LA.
- Illustration of rebalancing asymmetry:
  - If the U.S. current account deficit narrowed by "2 percentage points of U.S. GDP" and the adjustment were borne entirely by Latin America, then the region’s current account deficit would have to widen by "the equivalent of more than 6 percentage points of Latin America’s GDP."

### Why easy foreign financing and high terms of trade pose policy challenges now
- Potential benefits:
  - Financing investment and consumption, and improving balance sheet resilience through debt management.
  - Some degree of permanent appreciation and current account widening is an expected part of equilibrium adjustment.
- Risks from intensity and transitory components:
  - The transitory nature of parts of the tailwinds increases the chance of "substantial vulnerabilities and heightened risks of setbacks."
  - High commodity prices spur domestic absorption booms, enlarge government revenues, and appreciate the real exchange rate—effects similar to large capital inflows.
- Comparative advantages and differences from other EMs:
  - Many LA economies have improved frameworks (greater exchange rate flexibility, inflation targeting, better bank supervision, reduced public debt), which mitigate but do not eliminate risks.
  - LA differs from some Asian EMs by being more open, more flexible in exchange rates, and more often in current account deficit positions.

### Policy response: objectives and instruments
- Overarching goal: contain the risk of boom-bust cycles while allowing necessary equilibrium adjustments.
- Exchange rate policy:
  - Flexible exchange rates should play a key role in dampening incentives for capital inflows and currency mismatches while allowing warranted equilibrium appreciations.
  - Foreign exchange intervention should "avoid playing an early role and resisting fundamental shifts."
- Fiscal policy:
  - Fiscal policy needs at least to be acyclical, "undoing recent stimuli and saving temporary revenue gains."
- Macroprudential policy:
  - "Always-desirable macroprudential policies should continue being developed and intensified," with focus on segments prone to bubbles to contain financial vulnerabilities and reduce credit procyclicality.
- Capital account restrictions:
  - In the current exceptional global setting, the temporary use of capital account restrictions on macroeconomic stability grounds "could be considered" to avoid excessive risk from large current account deficits.
  - Caveat: adjustments in macroeconomic policies are "a key first priority," and restrictions should not be used to substitute for such adjustments.
  - When temporary and not substituting for core macro adjustments, such restrictions "can be viewed as a prudent move to prevent boom-busts, thereby contributing to global financial stability."

### Structure of the analysis in the note
- The note examines:
  - The unusual aspects of the current external environment conducive to strong capital inflows to LA (Section II).
  - Why today's easy foreign financing conditions are a concern for the region (Section III).
  - How Latin America should build its policy response (Section IV).

*Executive Summary, _sdn1107 - EXECUTIVE SUMMARY*

### Box 1. How Do Low Foreign Interest Rates and Capital Flows Affect the Macroeconomy?

### Box 1. How Do Low Foreign Interest Rates and Capital Flows Affect the Macroeconomy?

### Mechanisms linking low foreign interest rates, capital inflows, and the macroeconomy
- Basic transmission:
  - Low foreign interest rates → capital inflows to an EM economy → FX supply increases → EM currency appreciates (if policymakers allow appreciation).
  - Appreciation reduces competitiveness via expenditure-switching: export volumes fall and domestic demand shifts toward cheaper imports → net exports decline → aggregate demand and GDP decline.
  - EM policymakers can buy foreign exchange to resist appreciation, converting a larger current account deficit into accumulation of reserves; sterilization can be used to avoid inflationary effects from reserve accumulation.
- Important qualification: low foreign interest rates also stimulate domestic demand directly, which can raise GDP and inflation—capital inflows are not inherently contractionary.

### Key omitted dynamics and implications
- Low foreign interest rates stimulate domestic demand, inducing weaker current account balances financed by capital inflows; higher spending can raise GDP and inflation.
- FX intervention:
  - Sustains incentives for capital inflows and can lead to more inflows, strengthening the stimulus on domestic demand and weakening the current account; overall effect on the current account is unclear.
  - Sterilized FX intervention may need to occur at an accelerating pace to hold the nominal exchange rate to an objective.
  - Sterilization is unlikely to prevent the decline in effective borrowing costs for many domestic agents (corporate risk premia imply reduced external financing costs largely pass through), so sterilized intervention will not fully offset the domestic demand boost from lower foreign rates.
- Conclusion: an EM with an open capital account cannot fully insulate itself from capital inflows; main risks are overheating and demand-driven current account deterioration rather than recession. Exchange rate flexibility and fiscal policy are central tools to contain inflow impacts.

### Risks and vulnerabilities for Latin America (LA)
- Large external current account deficits are a critical vulnerability; the initial size of the current account deficit is a robust predictor of the likelihood of rapid reversals.
- Easy external financing conditions historically produce accelerations of domestic demand (notably in LA), which can lead to excessive absorption and vulnerability to reversal.
- Financial sector risks:
  - Excessive risk taking can amplify credit and asset bubbles and excess absorption.
  - Corporates with direct foreign financing access can bypass domestic prudential buffers, leading to over-leveraging and currency/maturity mismatches that can transmit to domestic banks.
  - A combination of financial distress and current account reversal (“double whammy”) compounds adjustment costs and prolongs recovery.
- Commodity exporters: commodity export volumes are likely to be maintained under appreciation because world prices are set in foreign currency and exporters are price takers (except where appreciation drives prices below marginal costs, which is judged unlikely given currently high global commodity prices).
- Empirical literature summary: inflows and resource booms induce real appreciation, resource shifts, and reduced exports, but do not necessarily reduce growth absent crisis conditions.

### Policy recommendations — overarching principles
- Use many policy margins as warranted by country circumstances; priority is to set macroeconomic policies right.
- Fiscal policy should shift away from expansionary bias; saving temporary fiscal revenues is paramount.
- Capital account restrictions can be considered in some cases but cannot substitute for macroeconomic adjustments; use them for macroeconomic stability to avoid excessive current account deficits rather than to target the exchange rate.
- Policy success should not be judged solely by the level of the exchange rate.

### A. Macroeconomic (fiscal and monetary) policy guidance
- Fiscal policy:
  - At a minimum, avoid procyclical fiscal policy—do not spend cyclical/temporary revenue gains.
  - Treat revenue growth in excess of growth of potential output (prudently estimated) as temporary unless attributable to lasting tax changes.
  - Be cautious about spending revenue gains driven by high commodity prices; consider saving temporary gains, investing abroad, or reducing debt depending on public debt structure and liquidity needs.
  - Consider active consolidation of the structural fiscal position where public debt is elevated or other structural concerns exist; current conditions offer an opportunity to accelerate consolidation.
  - Fiscal consolidation is unlikely to markedly raise capital inflows in LA given already high investor confidence and low spreads.
- Monetary policy:
  - Avoid over-reliance on monetary policy tightening to counter inflows, since higher policy rates attract carry-trade inflows; monetary policy should be coordinated with fiscal stance.

### B. Exchange rate policy and FX intervention
- Accept that real exchange rate appreciation is likely and can be cyclical and useful as a safety valve to relieve domestic demand pressures.
- Exchange rate flexibility:
  - Substantial nominal flexibility, including appreciation, helps limit capital inflows and deters currency mismatches by making exchange rate risks apparent.
  - Cross-country evidence links greater nominal flexibility to smaller booms in domestic demand and milder contractions when global financing tightens.
- FX intervention:
  - Sterilized intervention has unclear effectiveness on the nominal exchange rate and involves sterilization costs; resisting nominal appreciation can increase GDP volatility and deepen post-boom contractions.
  - Intervention is more defensible once the currency is clearly on the strong side, to break reinforcing cycles of animal spirits, capital/credit flows, and asset prices.
  - Intervention design principles: avoid fixed target prices, focus on amounts to be bought, consider announced end dates, and protect exchange rate flexibility.
  - With generally comfortable reserve buffers in LA, intervention decisions should be judged against net inflow size and current account deficits; countries with high deposit dollarization may consider some leaning to reduce future depreciation risks, mindful that intervention can slow de-dollarization.

### C. Macroprudential (MaP) and microprudential (MiP) policies
- Strengthen MiP and deploy MaP to enhance financial resilience and reduce procyclicality (address maturity and currency mismatches, risk-taking, and softening lending standards).
- MaP should:
  - Include targeted instruments and broad oversight; tailor tools to sectors (e.g., reserve requirements, dynamic provisioning, loan-to-value limits).
  - Address funding risks and incorporate borrower-level currency mismatch risk into regulations where relevant.
  - Encompass the entire financial spectrum, including shadow banking and corporate balance sheets.
  - Be implemented with clear institutional mandates, transparency, and coordination.
  - Recognize MaP is not a substitute for sound fiscal, monetary, and exchange rate policies; in cases where inflows bypass the banking system, MaP may be insufficient alone.

### D. Capital account restrictions — conditional, temporary, and targeted use
- Principles for use:
  - Temporary and limited to extraordinary circumstances where external current account deficits risk becoming clearly unsustainable.
  - Not a substitute for macroeconomic adjustments or MaP strengthening.
  - Aim to prevent excessive growth of absorption and widening of deficits; focus on underlying current accounts (strip cyclical components and temporary terms-of-trade effects).
  - Designed to raise domestic interest rates and contain private demand growth when other policies are insufficient or too slow.
- Design considerations:
  - Account for degree of capital market integration, institutional capacity, and whether restrictions represent a regime change with collateral costs.
  - Apply broadly across instruments and sectors (including FDI where necessary) to reduce circumvention channels.
  - Effectiveness evidence: controls can affect composition of inflows; evidence on total volume effects is mixed and tends to show diminished effectiveness over time as circumvention develops.

### Concluding guidance for Latin America
- Recommended policy mix:
  - Allow flexible exchange rate regimes to play cyclical and defensive roles against easy foreign financing;
  - Pursue fiscal policies that are at least acyclical and save temporary revenues;
  - Proactively strengthen microprudential frameworks and introduce/use macroprudential policies to shield the financial sector and reduce procyclicality;
  - Use temporary capital account restrictions in some circumstances to avoid excessive risk from large current account deficits, as a defensive move to preserve macroeconomic stability.
- Implementation reality:
  - Policy response likely needs to advance on multiple fronts at varying speeds due to implementation constraints and lags; capital account restrictions should not replace essential macroeconomic and macroprudential adjustments.

*Italic: Source: _sdn1107 - Box 1. How Do Low Foreign Interest Rates and Capital Flows Affect the Macroeconomy?_*

### References

### _sdn1107 - References

### IMF publications and chapters
- IMF, 2007, “Managing Large Capital Inflows,” Chapter 3, World Economic Outlook, October (Washington: International Monetary Fund).
- IMF, 2010a, “Challenges Arising from Easy External Financing Conditions,” Chapter 3, Regional Economic Outlook: Western Hemisphere, April (Washington: International Monetary Fund).
- IMF, 2010b, “Global Liquidity Expansion: Effects on ’Receiving’ Economies and Policy Response Options,” Chapter 4, Global Financial Stability Report, April (Washington: International Monetary Fund).
- IMF, 2010c, “Emerging Europe and the Global Crisis: Lessons from the Boom and Bust,” Chapter 3, Regional Economic Outlook: Europe, October, (Washington: International Monetary Fund).
- IMF, 2010d, “Macroprudential Tools in Latin America: A Primer,” Chapter 4, Regional Economic Outlook: Western Hemisphere, October (Washington: International Monetary Fund).
- IMF, 2010e, “Have Metals Become More Scarce, and What Does Scarcity Mean for Prices?” Box 1.5, in World Economic Outlook, October (Washington: International Monetary Fund).
- IMF, 2011, “Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework,” paper prepared for discussion by the IMF Executive Board (Washington: International Monetary Fund). Available via the Internet at: http://www.imf.org/external/pp/longres.aspx?id=4542

### IMF working papers, staff notes, and discussion notes
- Bakker, Bas B., and Anne-Marie Gulde, 2010, “The Credit Boom in the EU New Member States: Bad Luck or Bad Policies?” IMF Working Paper 10/130 (Washington: International Monetary Fund).
- Clements, Benedict J., and Herman Kamil, 2009, “Are Capital Controls Effective in the 21st Century? The Recent Experience of Colombia,” IMF Working Paper 09/30 (Washington: International Monetary Fund).
- Magud, Nicolas, and Sebastian Sosa, 2010, “When and Why Worry About Real Exchange Rate Appreciation? The Missing Link between Dutch Disease and Growth,” IMF Working Paper /10/271 (Washington: International Monetary Fund).
- Ostry, Jonathan D., Atish Ghosh, Karl Habermeier, Marcos Chamon, Mahvash S. Qureshi, and Dennis B.S. Reinhardt, 2010, “Capital Inflows: The Role of Controls,” IMF Staff Position Note 10/04, February (Washington: International Monetary Fund).
- Ostry, Jonathan D., Atish R. Ghosh, Karl Habermeier, Luc Laeven, Marcos Chamon, Mahvash S. Qureshi, and Annamaria Kokenyne, 2011, “Managing Capital Inflows: What Tools to Use?” IMF Staff Discussion Note 11/06 (Washington: International Monetary Fund). Available via the Internet at: http://www.imf.org/external/pubs/ft/sdn/2011/sdn1106.pdf
- Schindler, M., 2009, “Measuring Financial Integration: A New Data Set,” IMF Staff Papers, Vol. 56, No. 1, pp. 222–38.

### Academic articles, chapters, and unpublished notes
- Brunnermeier, Markus, Stefan Nagel, and Lasse H. Pederson, 2009, “Carry Trades and Currency Crashes,” in NBER Macroeconomics Annual 2008, ed. by Acemoglu, Rogoff, and Woodford, Chapter 5 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Canales-Kriljenko, J., 2010, “Demand Booms under Easy Foreign Money: The Role of Exchange Rate Flexibility” (unpublished note).
- Chinn, Menzie D., and Hiro Ito, 2008, “A New Measure of Financial Openness,” Journal of Comparative Policy Analysis, Vol. 10, September, pp. 309–22.
- De Gregorio, Jose, 2010a, “Tackling the Capital Inflow Challenge,” Economic Policy Paper 35, Central Bank of Chile, May.
- De Gregorio, Jose, 2010b, “Macroprudential Regulation, Financial Stability, and Capital Flows,” Economic Policy Paper No. 37, Central Bank of Chile, September.

*Source: _sdn1107 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2011/_sdn1107.pdf_