Volatile Capital Flows: Assessment of the Current Policy Environment

This paper reviews the international economic and financial situation currently and compares it to the 1990's and concludes that conditions are very different: it is unlikely that a crisis similar to those of the earlier period will occur now. Capital controls in the 1990s are examined in detail and two examples of the most highly regarded implementation of them – Chile and Malaysia – provide evidence that capital controls have a debatable and inconclusive effect on the variables policymakers are concerned with. Two types of policy interventions, " circuit breakers " and " bank holidays, " are described and used to define a spectrum of possible innovative controls to consider. This analysis concludes that innovative policies promising desired results different from those due to the types of capital controls tried in the past are difficult if not impossible to identify. The paper concludes that ABAC should advocate: (1) improvement in collection and dissemination of data useful in assessing potential liquidity problems and required by " early warning systems; " (2) possible controls on the flow of international capital should carefully weigh the short-term advantages, if any, against long-term costs, and if controls are implemented, implementation should be predictable and the controls transparent in application and neutral in impact; (3) policy discussions should focus reactions to the most likely crisis under current circumstances, for example a precipitous adjustment to the dollar in response to accumulating global imbalances. The current economic and financial market situation among the APEC emerging economies is substantially different than it was in the crisis period of the 1990s. With the floating of the Chinese and Malaysian currencies in July 2005, few of the regional currencies have a fixed peg to the dollar and most exchange rates demonstrate substantial variability. International reserve accumulations by emerging market economies in general are large, trade and capital accounts are roughly in balance compared to the large capital inflows and trade deficits characteristic of the crisis economies in the 1990's. Market conditions are improved, with valuations of stocks in general and of the financial sector strong, and of course, substantial changes in the capitalization and regulation of the financial sector has been undertaken since the crisis years. Hedge funds are on average smaller, less highly leveraged, more carefully scrutinized by their lenders, and pursue more heterogeneous strategies than in the 1990's. Based on a review of capital controls imposed by APEC emerging …