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Macroeconomic adjustment to capital inflows : Latin American style versus East Asian style

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  • Corbo, Vittorio
  • Hernandez, Leonardo

Abstract

In recent years, private capital inflows to some developing countries have increased sharply. This increase has provided the financing needed to enhance the use of existing capacity and to raise investment levels. But capital inflows produce their own problems. They can increase inflation and lead to exchange rate appreciation, for example. The authors review the macroeconomic repercussions of an increase in capital inflows. Generally, it will result in appreciation of the real exchange rate, a larger nontradable sector, a smaller tradable sector, and a larger trade deficit. Under a fixed exchange rate regime, it will also result in faster inflation and an accumulation of foreign reserves. Can government intervention minimize the size and effects of real exchange rateappreciation? The authors discuss different mechanisms that can be used to limit the appreciation - and discuss the difference, in this respect, between portfolio investment and external debt. Finally, they review and compare the recent experiences of four Latin American countries (Argentina, Chile, Colombia, and Mexico) and five East Asian countries (Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand), and discuss how these countries have dealt with the macroeconomic side effects of capital inflows. The authors found the following: All nine countries have avoided a permanent, significant increase in inflation, it can be argued. In Argentina and Mexico inflation has been decreasing for three or four years, and in the other seven countries it has remained stable. The countries that received the largest average capital inflows (as a proportion of GDP) in 1989-92 are not those that experienced the greatest exchange rate appreciation. In fact, the countries with the greatest capital inflows (Chile, Malaysia, and Thailand) have experienced either depreciation or low appreciation of their currencies. (Appreciation was lower in Thailand than in Korea despite much greater capital inflows in Thailand.) Countries with decreasing government consumption as a percentage of GDP (Chile, Indonesia, and Malaysia) showed less appreciation of the real exchange rate. Countries with increasing government consumption as a percentage of GDP (Argentina, Korea, Mexico, and the Philippines) showed the greatest appreciation of the real exchange rate, despite not receiving the greatest capital inflows.

Suggested Citation

  • Corbo, Vittorio & Hernandez, Leonardo, 1994. "Macroeconomic adjustment to capital inflows : Latin American style versus East Asian style," Policy Research Working Paper Series 1377, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1377
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    References listed on IDEAS

    as
    1. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1994. "The Capital Inflows Problem: Concepts And Issues," Contemporary Economic Policy, Western Economic Association International, vol. 12(3), pages 54-66, July.
    2. Carmen Reinhart & Leonardo Leiderman & Guillermo Calvo, 1993. "The Capital Inflows Problem; Concepts and Issues," IMF Policy Discussion Papers 93/10, International Monetary Fund.
    3. Corden, W M, 1984. "Booming Sector and Dutch Disease Economics: Survey and Consolidation," Oxford Economic Papers, Oxford University Press, vol. 36(3), pages 359-380, November.
    4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    5. 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.
    6. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-625, June.
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    Citations

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    Cited by:

    1. Renu Kohli, 2001. "Capital Flows and Their Macroeconomic Effects in India," IMF Working Papers 01/192, International Monetary Fund.
    2. Jeffrey D. Sachs & Aaron Tornell & Andrés Velasco, 1996. "Financial Crises in Emerging Markets: The Lessons from 1995," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 147-216.
    3. Ramkishen Rajan, 2010. "The Currency and Financial Crisis in Southeast Asia: A Case of 'Sudden Death' or Death Foretold'?," Working Papers id:2583, eSocialSciences.
    4. Beckerman, Paul & Das, Udaibir S., 1998. "Risk-Capital Inflows, Inflation, and Macroeconomic Policy in India, 1993-95," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 1), pages 359-383.
    5. Roberto Chang & Andrés Velasco, 2002. "The 1997-98 Liquidity Crisis: Asia versus Latin America," Central Banking, Analysis, and Economic Policies Book Series,in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Banking, Financial Integration, and International Crises, edition 1, volume 3, chapter 13, pages 413-452 Central Bank of Chile.
    6. Kiichiro Fukasaku & David Martineau, 1999. "Coopération monétaire en Asie de l'Est : l'apport des tests de causalité et de la cointégration," Économie et Prévision, Programme National Persée, vol. 140(4), pages 105-116.
    7. Montiel, Peter & Reinhart, Carmen M., 1999. "Do capital controls and macroeconomic policies influence the volume and composition of capital flows? Evidence from the 1990s," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 619-635, August.
    8. Renu Kohli, 2004. "Capital Account Liberalisation: Empirical Evidence and Policy Capital Account Liberalisation: Empirical Evidence and Policy Issues - I," International Finance 0405008, EconWPA.
    9. Melike Altinkemer, 2001. "Capital Inflows And Central Bank’s Policy Response," Discussion Papers 0103, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    10. Clara Garcia, 2004. "Capital Inflows, Policy Responses, and Their Ill Consequences: Thailand, Malaysia, and Indonesia in the Decade Before the Crises," Working Papers wp81, Political Economy Research Institute, University of Massachusetts at Amherst.
    11. Marcelo Soto & Salvador Valdés, 1996. "¿Es el Control Selectivo de Capitales Efectivo en Chile? Su Efecto sobre el Tipo de Cambio Real," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 77-108.
    12. Reinhart, Carmen & Montiel, Peter, 2001. "The Dynamics of Capital Movements to Emerging Economies During the 1990s," MPRA Paper 7577, University Library of Munich, Germany.
    13. Steven B. Kamin & Paul R. Wood, 1997. "Capital inflows, financial intermediation, and aggregate demand," International Finance Discussion Papers 583, Board of Governors of the Federal Reserve System (U.S.).
    14. Salvador Valdés-Prieto & Marcelo Soto, 1998. "The Effectiveness of Capital Controls: Theory and Evidence from Chile," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 25(2), pages 133-164, January.

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