A summary of the experiences of Chile and Colombia with unremunerated reserve requirements on capital flows during the 1990's

Financial integration among countries entails a series of well-known benefits. On the one hand, net inflows of external savings can complement national savings within an economy and therefore raise productive investment and income. On the other hand, capital mobility provides opportunities for portfolio diversification and risk sharing between countries and this may enable investors-both firms and households of particular countries- to achieve higher risk-adjusted rates of return. This in turn could encourage increases in savings and investment and therefore deliver faster rates of growth (Eichengreen and Mussa, 1998). Despite these benefits however, there is also a growing consensus that the opening of the capital account has contributed to economic volatility, especially in emerging economies. Financial integration has frequently led these economies to "import" external financial instability, given the highly volatile nature international financial markets and the strong association between the cycles of capital flows and those of domestic economic activity (Ffrench-Davis, 2007). Hence, for developing countries, capital account volatility has become one of the major sources of real macroeconomic instability (Ocampo, 2008). In what refers to Latin America, private capital flows have indeed been a lasting source of economic instability due to their highly pro-cyclical nature (Figure 1). Moreover, according to Ffrench-Davis (2007) the transmission of financial volatility into the region has been a key factor behind its poor economic and social performance since the early 1990's.