As the IMF and Bank of England predict that increasing volatility of global capital flows will motivate widespread use of capital controls, academics and civil society organisations are calling for coordinated global solutions.
New IMF research confirms the Fund’s cautious acceptance of capital controls (see Update 78, 75, 72) and incorporates source countries in the analysis. An IMF staff paper published in late November 2011, The multilateral aspects of policies affecting capital flows, points out that “gross inflows into emerging economies have become more volatile” as a consequence of “economic developments and policy actions in a small number of financial centres.” The paper argues that in order to reduce global capital flows’ riskiness, there is a “special urgency” to assign “the highest priority to upgrading national regulatory and supervision policies” in source countries.
The main message of the paper is that policymakers in source countries “should pay more attention to the multilateral effects of their policies”, especially in the area of financial sector regulation. However, “the complicated transmission of the multilateral effects weakens the case for major central banks to consider them actively in their monetary policy” and continues to explain that “using monetary policy to try to achieve a domestic objective and at the same time offset any negative cross-border impact, while helpful from a global perspective, might in practice be extremely difficult.” The executive board meeting on the paper saw most directors agree with these conclusions.
The staff paper also analyses the effects on neighbouring countries of capital flow measures (CFMs) in recipient countries. In the past the IMF has predicted that these measures “can be expected to reduce asset prices and inflows in the home country” but also “have the opposite effects on other countries in the region by diverting flows … to those countries.” The authors conclude that “empirical evidence … is inconclusive thus far.” The paper accepts that, “in theory, global welfare could be improved by a coordinated policy combination of expansionary advanced economy monetary policy coupled with the collective adoption of CFMs by emerging market economies (EMEs).” However, it warns of the potential risks of the proliferation of CFMs around the world, such as “the rise of financial protectionism … which would limit the benefits of financial globalisation … and escalate global costs.” They also point to “practical limitations” to achieving coordinated regulation, mainly “the constraints for OECD [Organisation for Economic Co-operation and Development] members from its Code of Liberalization of Capital Movements and for members of the EU subject to the Treaty on the Functioning of the European Union.”
A January IMF working paper, Surges, finds that easily changeable reversible factors like “the real US interest rate and global market uncertainty, determine whether there will be a surge of capital flows towards EMEs.” This means “the case of EMEs for imposing capital controls … may be correspondingly stronger.” Also, as local factors “also play a role in determining the allocation, then there may be a need for greater coordination between both source and recipient countries and among EMEs to ensure that they do not pursue beggar-thy-neighbor policies against each other.”
Correctionist, not protectionist
The staff paper proposes that the multilateral aspects should be included in the “previously proposed framework”, a code of conduct published in April 2011 but rejected by developing countries (see Update 76). In late November Kevin Gallagher of Boston University commented that “it’s great the IMF has complemented their existing research on this by looking at the industrialised world … it’s yet another wakeup call for the need to reinvent financial markets towards productive development.” He lamented however the idea of trying to revive the code of conduct: “Rather than pushing ahead on a globally enforceable code of conduct that could eventually lead to capital account liberalisation across the globe, the IMF should instead work to reduce the stigma attached to capital controls, protect countries’ ability to deploy them, and help nations police investors who evade regulation.”
In a January paper which reviews theoretical frameworks in capital account management, Kevin Gallagher also argues that capital account management techniques “are justified as an important part of the macroeconomic toolkit from a wide variety of theoretical perspectives within economics” and that, contrary to the claims in the popular press and by some in the economics profession “that capital controls are inherently protectionist measures, … capital controls [are] measures to correct for market failures in the world economy.”
Jorge Gaggero, from Buenos Aires-based think tank Cefid-Ar, said “that IMF research on capital flows throughout 2011 confirms that most staff at the Fund agree on the urgency of implementing capital account regulations but do not have the political space to openly challenge international finance treaties: they know there is no point in making policy proposals that the executive board will reject. The efficiency argument and the attempt to spread fears of financial protectionism are just a facade to hide the contradiction between their diagnosis and their lack of substantial proposals.”
Two December Bank of England reports argued that financial turbulence caused by volatile cross-border capital flows may increase in the future. The reports highlight the advantages of the Bretton Woods system of the post war period in which flows were regulated compared to the current period of instability, and concludes that capital controls might increasingly be deployed to deal with volatility. They also point out that a coordinated response would be more effective than unilateral initiatives.
Despite acknowledging that countries could use regulations on financial flows, the emphasis of the Bank of England reports is to tackle so-called imbalances from the trade side rather than the capital account side, saying “capital flows might be harder to measure and control in practice.” As pointed out by Peter Chowla from the Bretton Woods Project in a December post for the blog Triple Crisis, “the Bank of England’ s big idea is worrisome” because it “boils down to the UK following the US Senate in trying to slap import tariffs on Chinese goods.”
Several commentators argued in December that these publications are one more sign that the world is moving towards regulated cross-border capital flows. Gillian Tett argued in a Financial Times article that “financial globalisation has created a system that is interconnected in some dangerous ways” and that “what is really needed now is something akin to a new Bretton Woods style governance structure to enable policymakers to keep pace with the globalisation of capital flows.”
Breaking the mould
Two new reports released in December 2011 by Latin American NGO coalition LATINDADD and UK-based NGO the Bretton Woods Project show how a new pragmatic approach to regulation of financial flows can help ensure stability and development. One of the reports, Time for a new consensus, presents a set of policy recommendations at the national level and also points out to the need of regional and global coordination. The report argues that source and recipient countries “need to commence serious discussions … at the IMF or elsewhere, on how source countries can effectively contribute to the stability of financial flows.” The report also stresses that developing countries need to start working “in regional configurations to coordinate capital account management”, and that both “rich and developing countries need to coordinate to remove the policy hurdles resulting from investment treaties and free trade agreements.”
A second report, Breaking the mould, reviewed the evidence on the developmental impact of capital account management measures in Latin America. Co-author Jorge Coronado said that “the evidence collected shows that regulations on capital inflows and outflows are helping Latin America to achieve not only financial stability, but also to promote development goals like poverty reduction and employment creation. These findings challenge the current IMF stance, which gives inadequate consideration to the impact volatile capital flows have on economic activity and employment.” Coronado concluded that “the IMF should pay more attention to the views of developing countries’ authorities and stop clinging to socially destructive prescriptions.”
In February, further IMF research will cover capital account liberalisation and managing capital outflows. A policy paper to be discussed at the board in April will draw together previous and current work toward articulation “of a comprehensive, balanced, and flexible Fund institutional view on policies affecting capital flows drawing on country experiences, and thereby underpinning the provision of consistent and evenhanded policy advice, appropriate to country-specific circumstances.”