{ "title": "Old Dilemmas, New Challenges: Monetary Policy and Capital Flows into Emerging Economies", "publication": "IMF Blog, April 21, 2011", "sourceUrl": "https://www.imf.org/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies", "canonical": "https://www.imf.org/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies", "overlayPath": "/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/index.md", "summary": "Author: Leslie Lipschitz", "sections": [ { "heading": "Overview", "content": "- Author: Leslie Lipschitz\n- Date: April 21, 2011\n- Theme: Reassessment of policy challenges posed by large and volatile capital inflows into emerging market economies, drawing on recent experience in emerging European economies." }, { "heading": "Awkward dilemma", "content": "- Core argument:\n - Capital was scarce in emerging market economies relative to advanced economies, implying higher rates of return as technology and institutional effectiveness caught up.\n - Higher returns, together with the likely strengthening of emerging market currencies, would probably elicit large capital inflows.\n- Policy trade-offs for monetary authorities:\n - If monetary policy raised interest rates to contain demand, this would attract more capital inflows and lead to correspondingly larger current account deficits.\n - If interest rates were set relatively low to avoid inflows, domestic investment would far exceed saving, again producing large current account deficits.\n- Role of market discipline:\n - The dilemma could be resolved if market risk premiums took proper account of underlying vulnerabilities (like the size of the current account deficit), but this is conditional: “a rather big ‘if.’”\n- Warning signs on the path from inflows to crises:\n - very rapid credit expansion, much of it in foreign currency\n - asset price bubbles\n - a shift in resource allocation out of tradable goods and into nontraded assets (most obviously, housing)\n - substantial private sector vulnerability to foreign exchange risk\n - a sudden jump in market risk premiums, often for reasons unrelated to domestic policies" }, { "heading": "Benign or dangerous?", "content": "- Historical views:\n - Old view: capital inflows were wholly benign and helpful to development and growth by easing domestic financing constraints.\n - New view: surges in capital inflows can have seriously detrimental effects.\n- Mechanisms of harm:\n - Easing of credit conditions raises asset prices, chiefly real estate prices, diverting resources away from domestic manufacturing.\n - Overseas-funded bank loans can make real estate price increases self-reinforcing, leading to housing price bubbles and harm to export production." }, { "heading": "Theory becomes reality", "content": "- Experience in emerging European economies:\n - In the decade or so before the global financial crisis, rapid growth proceeded largely benignly until about 2003, driven by integration with advanced western European countries and booming trade.\n - Later warning signs emerged:\n - capital inflows fueled excessive credit expansion\n - very large foreign exposures increased vulnerability\n - resources shifted out of tradable goods and into nontraded assets\n - real estate booms took off\n - current account deficits widened\n - The global financial turbulence produced a reassessment of risk—a jump in market premiums—that interacted with these vulnerabilities to trigger crises:\n - housing bubbles were pricked and burst\n - foreign-financed bank credit dried up and harmed bank balance sheets\n - Outcome heterogeneity:\n - underlying vulnerabilities, and thus the severity and duration of the downturn, differed substantially across these countries" }, { "heading": "Live and learn — policy implications and recommendations", "content": "- Exchange rate regime considerations:\n - Fixed exchange rate regimes:\n - A fixed exchange rate, insofar as it is seen as an exchange rate guarantee, encourages rapid inflows and foreign exchange exposure, exacerbating vulnerabilities.\n - Under a fixed exchange rate it is very difficult to stop credit booms: rising inflation leads to a drop in real interest rates, further boosting demand for credit.\n - Floating exchange rate regimes:\n - Under a floating regime, countries can moderate excessive credit growth by letting the exchange rate strengthen.\n - Exchange rate appreciation will lower inflation, keep real interest rates higher, and possibly elicit a perception of foreign exchange risk.\n - Empirical contrast cited:\n - Poland and the Czech Republic—both of which have floating exchange rates—managed to avoid much of the overheating that took place in fixed exchange rate countries like Latvia, Lithuania and Bulgaria.\n - With much lower initial imbalances and vulnerabilities, Poland and the Czech Republic weathered the global crisis much better and have had much faster recoveries.\n- Strengthening monetary and broader stabilization policy:\n - Monetary policy—and policy to stabilize the economy more generally—needs substantial reinforcement, especially for countries with some inflexibility in their exchange rates because of their commitment to the euro or a particular path to euro adoption.\n - Stabilization requires policymakers to be keenly attuned to financial conditions and to draw on a menu of policy options, including:\n - the right structural reforms\n - appropriate macroeconomic policies\n - regulatory instruments (both micro- and macro-prudential)\n - taxes\n - in some cases, disincentives for foreign currency borrowing or lending\n\nSource: Old Dilemmas, New Challenges: Monetary Policy and Capital Flows into Emerging Economies — Leslie Lipschitz, April 21, 2011\n\n---\n\n\n References\n\n- have grappled with the idea\n- substantial private sector vulnerability to foreign exchange risk\n- emerging economies in Europe\n- menu of policy options\n- macro-prudential\n\nSource: https://www.imf.org/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies" } ], "bullets": [ "[Markdown version](/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/index.md)", "[Structured JSON version](/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/index.json)", "[Bundle manifest](/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/bundle-manifest.json)", "Authors: Leslie Lipschitz", "Published: April 21, 2011", "Author: Leslie Lipschitz", "Date: April 21, 2011", "Theme: Reassessment of policy challenges posed by large and volatile capital inflows into emerging market economies, drawing on recent experience in emerging European economies.", "Core argument:", "Policy trade-offs for monetary authorities:", "Role of market discipline:", "Warning signs on the path from inflows to crises:", "Historical views:", "Mechanisms of harm:", "Experience in emerging European economies:", "Exchange rate regime considerations:", "Strengthening monetary and broader stabilization policy:", "[have grappled with the idea](http://www.imf.org/external/pubs/ft/fandd/2002/09/lipschit.htm)", "[substantial private sector vulnerability to foreign exchange risk](http://www.imf.org/external/pubs/ft/fandd/2007/03/lipsch.htm)", "[emerging economies in Europe](http://blogs.imf.org/2010/10/20/emerging-europe%e2%80%94lessons-from-the-boom-bust-cycle/)", "[menu of policy options](http://www.imf.org/external/pubs/ft/survey/so/2011/NEW040511B.htm)", "[macro-prudential](http://blogs.imf.org/2010/10/22/macro-prudential-policies-putting-the-%E2%80%9Cbig-picture%E2%80%9D-into-financial-sector-regulation/)" ], "alternates": { "markdown": "/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/index.md", "json": "/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/index.json", "bundleManifest": "/en/blogs/articles/2011/04/21/monetary-policy-and-capital-flows-into-emerging-economies/bundle-manifest.json" }, "generatedAtUtc": "2026-08-28T14:35:53.626Z" }