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Too much capital sloshes around and needs regulation
By Jose Antonio Ocampo, Kevin P. Gallagher, and Stephany Griffith-Jones |
April 25, 2011, Monday
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CAPITAL-ACCOUNT regulations have been at the center of global financial debates for two years.
The reasons are clear: since the world has experienced a "multi-speed recovery," as the International Monetary Fund puts it, slow-growth advanced countries are maintaining very low interest rates and other expansionary monetary policies, while fast-growth emerging economies are unwinding the expansionary policies that they adopted during the recession.
This asymmetry has spurred huge capital flows from the former to the latter, which are likely to continue.
Emerging economies fear that this flood of capital will drive up their currencies' exchange rates, in addition to fueling current-account deficits and asset bubbles, which past experience has taught them is a sure recipe for future crises. The problem is compounded by the fact that one of the countries undertaking expansionary policies is the United States, which has the world's largest financial sector and issues the paramount global currency.
Small wonder, then, that several emerging economies are using capital controls to try to manage the flood. This, of course, contradicts the wisdom that the IMF and others have preached in the past - that emerging economies should free their capital accounts as part of a broader process of financial liberalization.
The G20 recognized in 2008 that unfettered finance can generate costly crises; thus, it decided to re-regulate finance. But it left cross-border capital flows entirely off the agenda, as if they were not a part of finance. Furthermore, by a twist of language, regulations affecting capital flows are pejoratively called "controls," rather than their correct name.
This is why it is so important that the IMF has taken steps to address the issue. In early April, the fund made public two documents, one presented to the board and a more technical "staff note," together with a statement by Managing Director Dominique Strauss-Kahn. These followed another technical note issued a year ago.
The basic conclusion of all of these documents is that regulations of cross-border capital flows can complement macroeconomic policy and so-called "macro-prudential" financial regulations. Indeed, it has been shown that countries that used such regulations were hit less severely by the recent global financial crisis, and many economists argue that this was also true of the 1997-1998 Asian financial crisis.
We know from experience that there are many regulations that make sense, not just those now sanctioned by the IMF. One of them is a reserve requirement on cross-border flows - successfully implemented in Chile, Colombia, and elsewhere - or, even better, on cross-border liabilities. Taxes on inflows can play a similar role, as can minimum-stay periods for capital inflows.
Prohibition of certain transactions for prudential reasons also makes sense, particularly for borrowing in foreign currencies by economic agents that do not have revenues in those currencies. Alternatively, if those economic actors borrow from domestic financial institutions, regulations could resemble recent measures adopted in Brazil and South Korea, which include high capital and provision requirements for the associated liabilities.
In the recent IMF document, the fund proposes a set of guidelines that countries should use for capital-account regulations (which they call "capital-flow management measures," or CFMs).
The guidelines correctly emphasize that these regulations should complement, not replace, counter-cyclical macroeconomic policies.
But they make CFMs seem like an intervention of last resort, to be used only after everything else has been tried: exchange-rate adjustments, reserve accumulation, and restrictive macroeconomic policies. The new IMF framework is welcome, but countries will need the freedom to manage their capital account more than ever in the years ahead.
(Jose Antonio Ocampo, former United Nations Under-Secretary-General for Economic and Social Affairs and former Finance Minister of Colombia, is professor and member of the Committee on Global Thought at Columbia University. Kevin Gallagher is professor of international relations at Boston University and Research Fellow at the Global Development and Environment Institute at Tufts University. Stephany Griffith-Jones is head of financial research of the Initiative for Policy Dialogue at Columbia University. Copyright: Project Syndicate, 2011. www.project-syndicate.org)
The reasons are clear: since the world has experienced a "multi-speed recovery," as the International Monetary Fund puts it, slow-growth advanced countries are maintaining very low interest rates and other expansionary monetary policies, while fast-growth emerging economies are unwinding the expansionary policies that they adopted during the recession.
This asymmetry has spurred huge capital flows from the former to the latter, which are likely to continue.
Emerging economies fear that this flood of capital will drive up their currencies' exchange rates, in addition to fueling current-account deficits and asset bubbles, which past experience has taught them is a sure recipe for future crises. The problem is compounded by the fact that one of the countries undertaking expansionary policies is the United States, which has the world's largest financial sector and issues the paramount global currency.
Small wonder, then, that several emerging economies are using capital controls to try to manage the flood. This, of course, contradicts the wisdom that the IMF and others have preached in the past - that emerging economies should free their capital accounts as part of a broader process of financial liberalization.
The G20 recognized in 2008 that unfettered finance can generate costly crises; thus, it decided to re-regulate finance. But it left cross-border capital flows entirely off the agenda, as if they were not a part of finance. Furthermore, by a twist of language, regulations affecting capital flows are pejoratively called "controls," rather than their correct name.
This is why it is so important that the IMF has taken steps to address the issue. In early April, the fund made public two documents, one presented to the board and a more technical "staff note," together with a statement by Managing Director Dominique Strauss-Kahn. These followed another technical note issued a year ago.
The basic conclusion of all of these documents is that regulations of cross-border capital flows can complement macroeconomic policy and so-called "macro-prudential" financial regulations. Indeed, it has been shown that countries that used such regulations were hit less severely by the recent global financial crisis, and many economists argue that this was also true of the 1997-1998 Asian financial crisis.
We know from experience that there are many regulations that make sense, not just those now sanctioned by the IMF. One of them is a reserve requirement on cross-border flows - successfully implemented in Chile, Colombia, and elsewhere - or, even better, on cross-border liabilities. Taxes on inflows can play a similar role, as can minimum-stay periods for capital inflows.
Prohibition of certain transactions for prudential reasons also makes sense, particularly for borrowing in foreign currencies by economic agents that do not have revenues in those currencies. Alternatively, if those economic actors borrow from domestic financial institutions, regulations could resemble recent measures adopted in Brazil and South Korea, which include high capital and provision requirements for the associated liabilities.
In the recent IMF document, the fund proposes a set of guidelines that countries should use for capital-account regulations (which they call "capital-flow management measures," or CFMs).
The guidelines correctly emphasize that these regulations should complement, not replace, counter-cyclical macroeconomic policies.
But they make CFMs seem like an intervention of last resort, to be used only after everything else has been tried: exchange-rate adjustments, reserve accumulation, and restrictive macroeconomic policies. The new IMF framework is welcome, but countries will need the freedom to manage their capital account more than ever in the years ahead.
(Jose Antonio Ocampo, former United Nations Under-Secretary-General for Economic and Social Affairs and former Finance Minister of Colombia, is professor and member of the Committee on Global Thought at Columbia University. Kevin Gallagher is professor of international relations at Boston University and Research Fellow at the Global Development and Environment Institute at Tufts University. Stephany Griffith-Jones is head of financial research of the Initiative for Policy Dialogue at Columbia University. Copyright: Project Syndicate, 2011. www.project-syndicate.org)
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