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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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  3. repec:chb:bcchwp:07 is not listed on IDEAS
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  5. Choon-Seng Lim & Vincent & Min B. Shrestha, 2009. "Capital Flows and Implication for Central Bank Policies in The SEACEN Countries," Research Studies, South East Asian Central Banks (SEACEN) Research and Training Centre, number rp76, May.
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  8. Victor Pontines & Reza Y. Siregar, 2012. "Exchange Rate Asymmetry and Flexible Exchange Rates under Inflation Targeting Regimes: Evidence from Four East and Southeast Asian Countries," Review of International Economics, Wiley Blackwell, vol. 20(5), pages 893-908, November.
  9. 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.
  10. 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, May.
  11. Paul R. Masson, 1998. "Contagion; Monsoonal Effects, Spillovers, and Jumps Between Multiple Equilibria," IMF Working Papers 98/142, International Monetary Fund.
  12. Sylwia Nowak & Sanjaya Panth & Ravi Balakrishnan & Yiqun Wu, 2012. "Surging Capital Flows to Emerging Asia; Facts, Impacts, and Responses," IMF Working Papers 12/130, International Monetary Fund.
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  15. Carmen Reinhart & Mohsin S. Khan, 1995. "Capital Flows in the APEC Region," IMF Occasional Papers 122, International Monetary Fund.
  16. Ilan Goldfajn & Poonam Gupta, 1999. "Does Monetary Policy Stabilize the Exchange Rate Following a Currency Crisis?," IMF Working Papers 99/42, International Monetary Fund.
  17. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. V�gh, 2003. "The Unholy Trinity of Financial Contagion," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 51-74, Fall.
  18. Viral V. Acharya & Lasse Heje Pedersen, 2004. "Asset Pricing with Liquidity Risk," NBER Working Papers 10814, National Bureau of Economic Research, Inc.
  19. 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.
  20. 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.
  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, May.
  22. 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.
  23. 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, May.
  24. Afonso Bevilaqua & Rodrigo Azevedo, 2005. "Provision of FX hedge by the public sector: the Brazilian experience," BIS Papers chapters, in: Bank for International Settlements (ed.), Foreign exchange market intervention in emerging markets: motives, techniques and implications, volume 24, pages 119-26 Bank for International Settlements.
  25. Christopher J. Neely, 1999. "An introduction to capital controls," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 13-30.
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