Capital Account Regulations and Macroeconomic Policy: Two Latin American Experiences

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.(This abstract was borrowed from another version of this item.)