What I Learnt in Rio: Discussing Ways to Manage Capital Flows

IMF Blog, June 3, 2011

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Canonical URL: What I Learnt in Rio: Discussing Ways to Manage Capital Flows

Author and date: Olivier Blanchard, June 3, 2011.
Event: Conference in Rio de Janeiro, Brazil, organized jointly by the Brazilian authorities and the IMF, focused on managing capital flows.
Participation: Experts from both demand and supply sides, including practitioners and academics.
Notes taken: "I took 32 pages of notes during the conference."

Capital controls debates are highly technical despite strong ideological overtones.
Governments have five tools to adjust to capital flows: monetary policy, fiscal policy, foreign exchange intervention, prudential tools, and capital controls.
The challenge: "to find, for each case, the right combination."
The costs and benefits of capital flows depend heavily on country-specific institutional frameworks, including:
- exchange rate regime,
- degree of dollarization of the economy,
- credibility of the central bank.
Some commonly cited costs such as those related to "Dutch Disease" are "not well established."
IMF reconsideration: "Over the past 18 months, we at the IMF have done some rethinking about the nature of the risks capital flows may bring, and how best to respond."

Higher flows to emerging markets may represent a "new normal" driven by a "fundamental re-rating of global risk" in favor of emerging market assets with better fundamentals and higher returns.
Uncertainty remains whether foreign investor appetite for local currency debt reflects a durable shift or a temporary expectation of appreciation.
Policy should reflect the nature of specific investors: many inflows and outflows originate from domestic investors, implying that "targeting nonresidents is largely misguided" when domestic investors are the source.

No tool is foolproof: "None of the tools—be they reserve accumulation, prudential measures, or capital controls—are water-tight."
Recommended approach: move away from strict policy orderings toward a more fluid strategy of using "many or most of the tools most of the time" instead of "this now, that later".
Observed policy diversity may reflect either different country circumstances or suboptimal responses. Examples highlighted:
- Chile relies on foreign exchange intervention, not on capital controls.
- India relies on capital controls, not on foreign exchange intervention.
Question posed: "Are these corner solutions really optimal?"

Multilateral dimension and spillovers:
- Quoted remark by Min Zhu: "ensuring that countries reap the full benefits of capital flows is a shared responsibility between advanced and emerging market economies, between surplus and deficit countries, between capital-exporters and capital-importers."
- Key unanswered questions: What responsibilities do source countries have? Should source-country monetary policies account for spillovers? Do capital controls produce "beggar thy neighbor" effects?
- Evidence presented at the conference suggested spillovers across recipient countries "were not very large," but theoretical and further empirical work is "badly needed."
Capital account openness:
- Need to reassess "the current wisdom on capital account openness" in light of new research.
- Questions: What guidance should be given to policymakers with mostly open versus mostly closed capital accounts? Should countries such as Chile and China converge along the openness continuum, and at what rate?
Call for broader engagement: the conference emphasized consulting financial sector experts, academics, and outside researchers to deepen understanding of intermediation and policy impacts.

The Rio discussions advanced a more constructive, updated approach to managing capital flows, reducing emphasis on the polarizing legacy of the capital controls debate.
The work is "just the beginning of a conversation" and the IMF looks forward "to continuing the conversation as we work with members to find a way toward the right combination of policies."

Source: Olivier Blanchard, June 3, 2011 — What I Learnt in Rio: Discussing Ways to Manage Capital Flows