(Version in Español)
Last week I travelled to Rio de Janeiro in Brazil to participate in a conference on managing capital flows. Organized jointly by the Brazilian authorities and the IMF, the conference brought together experts from both the demand and supply sides of the issue, including many with a wealth of hands-on experience.
The discussion was rich and informative. Clearly we still have a lot to learn about the optimal approach to managing capital flows, about the right policy tools, and the right combination of tools.
To start with two general, but important observations.
First, while the issue of capital controls is fraught with ideological overtones, it is fundamentally a technical one, indeed a highly technical one. Put simply, governments have five tools to adjust to capital flows: monetary policy, fiscal policy, foreign exchange intervention, prudential tools, and capital controls. The challenge is to find, for each case, the right combination. This is not easy.
Second, we need to better understand the costs and benefits of capital flows. The costs depend―more than is generally understood―on the institutional framework in each country: things like the exchange rate regime, the degree of dollarization of the economy, and the credibility of the central bank. Even costs related to ‘Dutch Disease’―the bogeyman still much in the minds of policy-makers―are in fact not well established.
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. The most recent research attempts to develop a conceptual framework to weigh the benefits of different policy responses, including capital controls. Like the re-examination of many economic principles in the wake of the global crisis, this work is just the beginning of a conversation. The Rio conference highlighted the importance of consulting and debating the issues more broadly, particularly with financial sector experts who understand and influence intermediation, but also with academics and outside researchers. The conference gave me a better appreciation of the universe of issues, and of the outreach and research still to do.
I took 32 pages of notes during the conference; I will not impose them on you, but here are some highlights.
On the nature of flows…
- Looking at the relevant set of investors suggests higher flows to emerging markets are here to stay. This is the “new normal”, and is based on a “fundamental re-rating of global risk” in favor of emerging market assets with better fundamentals and higher returns. But, it remains to be seen whether, for example, the new appetite of foreign investors for local currency debt comes from a durable shift in demand, or the more temporary expectation of appreciation.
- The nature of specific investors must inform the policy choices. We often think of inflows and outflows as coming from primarily from decisions by foreign investors. The reality is that many of these inflows and outflows often come from decisions by domestic investors. When this is the case, targeting nonresidents is largely misguided.
On the policy options…
- None of the tools—be they reserve accumulation, prudential measures, or capital controls—are water-tight. So we should move away from strict policy orderings toward a more fluid approach of using “many or most of the tools most of the time” instead of “this now, that later”.
- It is not clear that the diversity of approaches we observe in practice comes from different circumstances, or from suboptimal responses. It was interesting to observe for example that Chile relies on foreign exchange intervention, not on capital controls, but India, instead, relies on capital controls, not on foreign exchange intervention. Are these corner solutions really optimal?
There were many other important technical issues beyond these and I’d encourage you to read some of the interesting presentations by the participants and speakers, including remarks by Professor Jagdish Bhagwati, on the Rio conference website.
There were some issues that I would like to have seen explored more fully.
One was the multilateral angle. As my IMF colleague Min Zhu said in his opening remarks, “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.” The challenge is to translate this into practice. What is the actual responsibility of source countries? Should they take it into account in conducting monetary policy, and if so, how? Should we worry about the “beggar thy neighbor” effect of controls? Some of the evidence presented at the conference suggested that these spillovers across recipient countries were not very large. Theoretical and further empirical work is badly needed here.
Nor did we have an opportunity to revisit, or even discuss, the current wisdom on capital account openness. In light of new research, what should we be telling policy-makers, those with mostly open and those with mostly closed capital accounts? Should Chile and China eventually converge to the same point along the continuum? And, if so, at what rate? We cannot avoid coming to views on this fundamental issue.
Overall, our discussions in Rio were a positive step toward a more constructive, updated approach, away from the contentious legacy of the capital controls debate. We look forward to continuing the conversation as we work with members to find a way toward the right combination of policies.