This latest research is part of work begun over a year ago, and now endorsed by the IMF’s Executive Board, to develop a pragmatic, experience-based approach to help countries manage large capital inflows. Until last year, capital controls were not seen as part of the policy toolkit, now they are.
The IMF is studying the originators of capital flows, known as the “push” forces. Reports on the effects that policies in one country or group of countries might have on others, known as spillovers, are being prepared for the world’s five largest systemic economies—China, the euro area, Japan, the United Kingdom and the United States.
While capital flows are generally beneficial for receiving countries, surges in inflows carry risks for their economies and financial systems. IMF research finds that policy responses to inflows have varied considerably, in part because of the differences between countries and the nature of the capital inflows in each case.
Surges in inflows can pose challenges, such as rapid currency appreciation, and a buildup in financial sector fragilities, such as those stemming from asset price bubbles or rapid credit growth, or the risk of a sudden stop or reversal of inflows. The management of capital inflows “covers a whole swath of economic policies,” said IMF Managing Director Dominique Strauss-Kahn in his statement to the Executive Board. These issues are central to the role of the IMF.
IMF research: common ground and lessons
The following key principles form the foundation of an organising framework around which national authorities can formulate policies:
1. No “one-size-fits-all”. The right policy mix will depend on each country’s circumstances, including the state of the domestic economy and the nature and magnitude of the capital inflows.
2. Structural reforms are always encouraged. Policies designed to increase the capacity of the economy to absorb capital inflows, for example by creating deeper domestic capital markets, should be pursued under all circumstances.
3. There are no substitutes for the right macro policies. Any response has to give primacy to macroeconomic policies. Measures specifically designed to influence inflows cannot be a substitute for the implementation of appropriate macroeconomic policies.
4. Capital controls are part of the policy toolkit. As explained recently by the Managing Director, capital controls can be used on a case-by-case basis, in appropriate circumstances.
5. Design the medicine to treat the ailment. Capital flow management measures should match the specific macroeconomic or financial stability concerns in question. In general, these measures should maximise efficiency and minimise distortions, and should be withdrawn when risks recede.
6. Think of others. Policies that might affect the external stability of other countries and, by extension, global financial stability or growth prospects, should be discouraged. In this regard, the framework suggests giving preference to measures that do not discriminate on a residency basis. This reflects the Fund’s multilateral mandate to promote systemic stability and foster global policy coordination.
The effectiveness of the policy framework will be analysed and adjusted over time, particularly in light of the impact that policies in one country or group of countries might have on others.
© International Monetary Fund
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