The global crisis, in its evolving phases since 2007, has vividly demonstrated the extent to which cross border capital flows tie economies together. From the spread of the crisis from the United States to the global economy in 2008, to the jitters caused across the world‘s financial markets by recent tensions in the Euro Area, with surges of inflows into fast growing emerging markets, and more recently into ―safe haven‖ currencies, it is clear that the world economy has a strongly interconnected financial system. The stability of this system can be considered a global public good.
As with many public goods, global stability is “undersupplied.” This is partly due to market failures that may warrant policy adjustments, but also because individual countries may not take full account of the effects of their policies on other countries and on the system as a whole. Indeed, a survey conducted by the G20 showed that the vast majority of authorities either were unaware or unable to quantify the impact on capital flows of their own policies, although several pointed to spillovers from the policies of others.
This recognition has led to interest in trying to develop global understandings on the management of cross border capital flows to promote stability. In December 2010, the IMF‘s Executive Board observed that, despite the complex interdependencies and channels for policy spillovers created by capital flows, there are no universal ―rules of the road‖ for them, in contrast to arrangements governing trade in goods and services. In this light, Directors saw merit in developing a coherent Fund view on capital flows and the policies that affect them. Such a view could help establish a framework for the purposes of the Fund‘s surveillance on capital account and possibly other policies affecting capital flows. In April 2011, the Board endorsed a first building block, namely a possible framework for managing capital inflows, and noted that a comprehensive and balanced approach to capital flows is required, taking into account both capital recipients and capital originators. More recently, the IMFC identified as a priority further work on a comprehensive, flexible and balanced approach for the management of capital flows, drawing on country experiences.
Macroeconomic policies may be the main policy driver of capital flows. However, it is prudential policies that shape their riskiness. This is also the policy area most in flux and thus where the reforms of national and international frameworks—including for macroprudential policies—now underway could better take multilateral transmission into account, alongside domestic considerations. Regarding the multilateral implications of monetary policy in large advanced economies, the evidence is more textured—policy does appear to have a direct impact on flows, but that could be offset at least in part by indirect effects on global demand and growth. Thus, the case for addressing the multilateral effects through monetary policy is much less clear-cut. Similarly, recent CFMs have had mixed cross-border transmission thus far, and their unilateral effectiveness is modest, suggesting, at this juncture, that the multilateral implications are limited.
Recognizing The Facts of Capital Flows
The crisis is prompting a reconsideration of some of the accepted stylized facts about destabilizing capital flows and the policies that affect them. A renewed look at the stylized facts raises questions that underscore the importance of the multilateral transmission of the policies that affect capital flows.
Recent experience shows that gross flows between advanced economies embed risks with systemic stability implications. Previous crises had led to a focus on net flows to EMEs, and on the composition of flows (short-term financing, exchange rate risk). These insights, drawn from analysis of EME crises such as those in East Asia and Latin America,...