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Capital Account Regulations and Macroeconomic Policy: Two Latin American Experiences

  • Guillermo Le Fort
  • Carlos Budnevich

The regulations that limit international financial integration have been at the center of a recent policy debate. Any developing economy can benefit from financial development, but international financial integration implies the risk of macroeconomic instability. The approach that has been favored in Chile and Colombia is one of gradual and limited financial integration, attempting to increase the effectiveness of monetary and exchange rate policies. The reduction in the risk premiurn demanded by investors has created downward pressure on domestic real interest rates, however a lower interest rate would increase domestic expenditure, the price level and the current account deficit. Among the policies put into effect to deal with this problem are increasing exchange rate flexibility and taxing external financing. Both countries have registered a successful macroeconomic performance, with the success partly owing to effective capital account regulation. The effectiveness of the regulations is shown in that a once and for all currency appreciation followed by a depreciating trend has been avoided, and that the current account deficit has been kept at sustainable levels. In other words, capital account regulations have avoided the overshooting (over appreciation) of the real exchange rate that would have occurred with large amounts of short term capital inflows. Using stronger restrictions on capital flows, quantitative limits for example, would not only create very significant microeconomic costs and slow economic and financial developments, but also most likely would be ineffective.

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Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_162.

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Date of creation: May 1996
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Handle: RePEc:lev:wrkpap:wp_162
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  1. Dornbusch, Rudiger, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 141-53, February.
  2. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
  3. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
  4. Poole, William, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, MIT Press, vol. 84(2), pages 197-216, May.
  5. Ffrench-Davis, Ricardo, 1990. "Debt-Equity Swaps in Chile," Cambridge Journal of Economics, Oxford University Press, vol. 14(1), pages 109-26, March.
  6. José Darío Uribe, 1995. "Flujos de Capital en Colombia: 1978-1994," BORRADORES DE ECONOMIA 002733, BANCO DE LA REPÚBLICA.
  7. Razin, Assaf & Sadka, Efraim, 1991. "Efficient investment incentives in the presence of capital flight," Journal of International Economics, Elsevier, vol. 31(1-2), pages 171-181, August.
  8. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America," MPRA Paper 13843, University Library of Munich, Germany.
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