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Financial Contagion and Volatile Capital Flows

  • Gan-Ochir Doojav
  • Borkhuu Gotovsuren
  • Tsenddorj Dorjpurev

Liberalized capital accounts and financial integration can enrich a country’s welfare as long as they are appropriately coordinated with the adequate strengthening of policy frameworks. Otherwise, volatile capital flows and financial contagion, promulgated by capital account liberalization and financial integration may lead to domestic macroeconomic and financial challenges via the transmission of international shocks into an economy that is highly vulnerable to external shocks. Thus, economies face a key challenge as to how to reap the maximum benefits from using capital inflows to enhance economic growth while minimizing their associated risks. Obviously, both financial contagion and volatile capital flows should not be seen as primary reasons for countries to de-liberalize their capital accounts. Instead, policy frameworks should be strengthened to better manage volatile capital flows. Although there are no magic solutions to effectively manage capital flow surges, countries need a conceptual framework to manage volatile capital flows to enhance their resilience to external shocks. The “capital flow management” framework may include a package of available policy options including macroeconomic policies, prudential measures and capital controls. Macroeconomic policies have to be the primary response to volatile capital flows. Since capital flows are commonly pro-cyclical and much more volatile, counter cyclical macro policies can essentially smooth out the business cycle. Beyond macroeconomic policies, authorities have available conventional prudential regulations and capital controls to manage the risks from volatile capital flows. When financial sector supervision is efficient and effective, prudential measures are the obvious choice. Capital controls are an essential component of the policy toolkit in dealing with capital flows in certain circumstances. In all circumstances, structural reforms to improve the capability of the economy to absorb capital inflows by deepening domestic financial markets, are always to be encouraged.

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This book is provided by South East Asian Central Banks (SEACEN) Research and Training Centre in its series Occasional Papers with number occ56 and published in 2012.
ISBN: 978-983-9478-23-5
Handle: RePEc:sea:opaper:occ56
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  10. Mohsin S. Khan, 1998. "Capital Flows to Developing Countries: Blessing or Curse?," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 37(4), pages 125-151.
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  12. Reza Y. Siregar & Vincent C.S. Lim & Victor Pontines & Jami’ah Jaffar & Nurulhuda M. Hussain, 2011. "Capital Flows Management During the Post-2007 Global Financial Crisis: The Experiences of SEACEN Economies," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp85.
  13. Reinhart, Carmen & Smith, R. Todd, 1998. "Too much of a good thing: The macroeconomic effects of taxing capital inflows," MPRA Paper 13234, University Library of Munich, Germany.
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  16. repec:chb:bcchwp:07 is not listed on IDEAS
  17. Graciela L. Kaminsky & Carmen Reinhart & Carlos A. Vegh, 2003. "The Unholy Trinity of Financial Contagion," NBER Working Papers 10061, National Bureau of Economic Research, Inc.
  18. Carmen Broto & Javier Díaz-Cassou & Aitor Erce-Domínguez, 2008. "Measuring and explaining the volatility of capital flows towards emerging countries," Banco de Espa�a Working Papers 0817, Banco de Espa�a.
  19. Fernando Broner & Roberto Rigobon, 2004. "Why are capital flows so much more volatile in emerging than in developed countries?," Economics Working Papers 862, Department of Economics and Business, Universitat Pompeu Fabra.
  20. Reza Siregar & Victor Pontines & Nurulhuda Mohd Hussain, 2010. "The US Sub-prime Crises and Extreme Exchange Market Pressures in Asia," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp75.
  21. Vincent C.S. Lim & Victor Pontines, 2012. "Global Imbalances: A Primer," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp86.
  22. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows: The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
  23. International Monetary Fund, 2011. "Macroprudential Policy; What Instruments and How to Use them? Lessons From Country Experiences," IMF Working Papers 11/238, International Monetary Fund.
  24. Reinhart, Carmen & Khan, Mohsin, 1995. "Capital Flows in the APEC Region," MPRA Paper 8200, University Library of Munich, Germany.
  25. Akira Ariyoshi & Andrei Kirilenko & Inci Ötker & Bernard Laurens & Jorge Iván Canales Kriljenko & Karl Friedrich Habermeier, 2000. "Capital Controls: Country Experiences with Their Use and Liberalization," IMF Occasional Papers 190, International Monetary Fund.
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