Capital Flows: Causes, Consequences and Policy Responses

Capital inflows have played an important role in promoting growth in many developing and transitional economies. Yet they have also been associated with volatility in variables that central banks use as targets of monetary policy, such as monetary growth, the exchange rate and inflation. This Handbook builds a framework for analysing capital flows, and discusses the circumstances in which different types of flows may have benefits and costs. Many capital flows are a (sometimes rapid) response to changes in the way investors perceive domestic developments in a particular economy. The Handbook argues that identification of the the cause of inflows is very important in determining an appropriate policy response. Such analysis can be performed in the context of a general assessment of how close the economy is to domestic and external equilibrium. Key questions to ask in the face of capital flows are "Is the exchange rate valued appropriately?" "What can be done to offset any excess demand in the economy?" and finally "Is financial instability a cause for concern?". The appropriate policy response depends upon answers to such questions. The Handbook assesses the various policy options available in the context of experience from a wide range of countries. This handbook is also available in Russian and Spanish.