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Macroeconomic adjustment to capital inflows : Latin American style versus East Asian style

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  • Corbo, Vittorio
  • Hernandez, Leonardo
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    Abstract

    In recent years, private capital inflows to some developing countries have increased sharply. This increase has provided the financing needed to enhance the use of existing capacity and to raise investment levels. But capital inflows produce their own problems. They can increase inflation and lead to exchange rate appreciation, for example. The authors review the macroeconomic repercussions of an increase in capital inflows. Generally, it will result in appreciation of the real exchange rate, a larger nontradable sector, a smaller tradable sector, and a larger trade deficit. Under a fixed exchange rate regime, it will also result in faster inflation and an accumulation of foreign reserves. Can government intervention minimize the size and effects of real exchange rateappreciation? The authors discuss different mechanisms that can be used to limit the appreciation - and discuss the difference, in this respect, between portfolio investment and external debt. Finally, they review and compare the recent experiences of four Latin American countries (Argentina, Chile, Colombia, and Mexico) and five East Asian countries (Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand), and discuss how these countries have dealt with the macroeconomic side effects of capital inflows. The authors found the following: All nine countries have avoided a permanent, significant increase in inflation, it can be argued. In Argentina and Mexico inflation has been decreasing for three or four years, and in the other seven countries it has remained stable. The countries that received the largest average capital inflows (as a proportion of GDP) in 1989-92 are not those that experienced the greatest exchange rate appreciation. In fact, the countries with the greatest capital inflows (Chile, Malaysia, and Thailand) have experienced either depreciation or low appreciation of their currencies. (Appreciation was lower in Thailand than in Korea despite much greater capital inflows in Thailand.) Countries with decreasing government consumption as a percentage of GDP (Chile, Indonesia, and Malaysia) showed less appreciation of the real exchange rate. Countries with increasing government consumption as a percentage of GDP (Argentina, Korea, Mexico, and the Philippines) showed the greatest appreciation of the real exchange rate, despite not receiving the greatest capital inflows.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1377.

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    Date of creation: 30 Nov 1994
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    Handle: RePEc:wbk:wbrwps:1377

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    Related research

    Keywords: Macroeconomic Management; Economic Stabilization; Economic Theory&Research; Financial Economics; Environmental Economics&Policies;

    References

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    1. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1994. "The Capital Inflows Problem: Concepts And Issues," Contemporary Economic Policy, Western Economic Association International, vol. 12(3), pages 54-66, 07.
    2. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-25, June.
    3. Corden, W M, 1984. "Booming Sector and Dutch Disease Economics: Survey and Consolidation," Oxford Economic Papers, Oxford University Press, vol. 36(3), pages 359-80, November.
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    Citations

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    Cited by:
    1. Renu Kohli, 2004. "Capital Account Liberalisation: Empirical Evidence and Policy Capital Account Liberalisation: Empirical Evidence and Policy Issues - I," International Finance 0405008, EconWPA.
    2. Salvador Valdés-Prieto & Marcelo Soto, 1998. "The Effectiveness of Capital Controls: Theory and Evidence from Chile," Empirica, Springer, vol. 25(2), pages 133-164, January.
    3. Reinhart, Carmen & Montiel, Peter, 2001. "The Dynamics of Capital Movements to Emerging Economies During the 1990s," MPRA Paper 7577, University Library of Munich, Germany.
    4. Ramkishen Rajan, 2010. "The Currency and Financial Crisis in Southeast Asia: A Case of 'Sudden Death' or Death Foretold'?," Working Papers id:2583, eSocialSciences.
    5. David Martineau & Kiichiro Fukasaku, 1999. "Coopération monétaire en Asie de l'Est : l'apport des tests de causalité et de la cointégration," Économie et Prévision, Programme National Persée, vol. 140(4), pages 105-116.
    6. Renu Kohli, 2001. "Capital Flows and Their Macroeconomic Effects in India," IMF Working Papers 01/192, International Monetary Fund.
    7. Reinhart, Carmen & Montiel, Peter, 1999. "Do capital controls influence the volume and composition of capital flows? Evidence from the 1990s," MPRA Paper 13710, University Library of Munich, Germany.
    8. Clara Garcia, 2004. "Capital Inflows, Policy Responses, and Their Ill Consequences: Thailand, Malaysia, and Indonesia in the Decade Before the Crises," Working Papers wp81, Political Economy Research Institute, University of Massachusetts at Amherst.
    9. Roberto Chang & Andrés Velasco, 2002. "The 1997-98 Liquidity Crisis: Asia versus Latin America," Central Banking, Analysis, and Economic Policies Book Series, in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (S (ed.), Banking, Financial Integration, and International Crises, edition 1, volume 3, chapter 13, pages 413-452 Central Bank of Chile.
    10. Melike Altinkemer, 2001. "Capital Inflows And Central Bank’s Policy Response," Discussion Papers 0103, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    11. Marcelo Soto & Salvador Valdés, 1996. "¿Es el Control Selectivo de Capitales Efectivo en Chile? Su Efecto sobre el Tipo de Cambio Real," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 77-108.

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