Bloomberg News

Central Banks Don’t Have to Consider Capital Flows, IMF Says

November 29, 2011

(Adds recommendations from report, analyst comment starting in seventh paragraph.)

Nov. 29 (Bloomberg) -- The effect of advanced economies’ monetary policies on capital flows to other countries is too complex to be taken into account by central banks such as the Federal Reserve, the International Monetary Fund staff said in a report.

Low interest rates in major developed economies including the U.S. have played a role in boosting capital flows to emerging markets where interest rates were higher, the IMF said in a report released today. At the same time, the Fed’s efforts to ease monetary policy may have helped support the U.S. economy, slowing the flow of capital elsewhere, it said.

“The complicated transmission of the multilateral effects weakens the case for major central banks to consider them actively in their monetary policy,” IMF staff wrote in the report. “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 report follows guidelines drafted by the IMF in March that endorse controls in limited circumstances for countries striving to manage inflows of overseas capital, which put upward pressure on their currencies and threaten to inflate asset-price bubbles. Countries such as Brazil have been asking for the IMF to look at the source of capital flows rather than just the recipients.

Creating Risks

The report, which was written Oct. 13, recommends that policy makers in advanced economies pay more attention to the risks their policies can create for others. Rather than focusing on monetary policy, the IMF staff recommends implementing quickly the changes to financial regulation that are in the works.

“There is strong evidence that in the runup to the crisis and in its early stages shortcomings in regulation and supervision allowed banks and other market participants regulated by advanced economies to take excessive cross-border risks that led to macrofinancial instability in recipient countries,” according to the report.

Supervisors in rich countries also didn’t grasp the risks in activities that fell outside their perimeter and were not regulated, such as over-the-counter derivative products, IMF staff said. Better regulation and supervision would have helped domestic stability and made capital flows safer, they said.

“It’s great the IMF has complemented their existing research on this by looking at the industrialized world,” said Kevin Gallagher, associate professor of international relations at Boston University. “It’s yet another wakeup call for the need to reinvent financial markets towards productive development.”

--Editors: Kevin Costelloe, Gail DeGeorge

To contact the reporter on this story: Sandrine Rastello in Washington at srastello@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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