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This article examines the causes and effects of the real exchange rate appreciation in Colombia during the 1990s. The substantial appreciation of the real exchange rate during the 1990s was an important factor contributing to the economic crisis of 1998-2000. While a number of Colombian economists have argued that the real appreciation was an equilibrating response to real shocks, such as rising fiscal deficits, petroleum discoveries, and increased productivity, this paper argues that nominal variables (including the nominal exchange rate, monetary policy and capital flows) also played an important role. These transitory shocks caused the real exchange rate to overshoot its long-run equilibrium, contributing to the recent economic crisis and the necessity for the large nominal depreciation of the peso in 1998-99.

Capital controls and the real exchange rate: Do controls promote disequilibria?

Economist have always considered capital as the central element of the process of economic development, the study aimed to establish the effects of capital control liberalization on monetary policy in Kenya. The Economists view that foreign investment benefits developing economies by increasing the availability of capital still holds, based on this view, the capital deficient countries heavily resort to for- eign financing as the primary source to achieve rapid economic growth and through their positive im- pact over productivity and the general economic wellbeing of the host country. Kenyan economy has accumulated a large external debt and are now facing serious debt servicing problems. The growth ex- perience of East Africa has received worldwide attention this is because Africa is seen as a new center for growth and can be an investment destination for other regions. This study is motivated on the as- sumption that this discussions ignored the experiences of developing countries in their early phase of industrialization. In addition there is a lack of proper attention on the analysis of the issue of capital inflows in the context of neo-liberal economic reforms and financial deregulation. Large swings in capital flows into and out of emerging markets can potentially lead to excessive volatility in asset pric- ing and supply of credit in the economy. In order to lessen the impact of capital flows on financial in- stability, a number of studies and policy makers have proposed the use of capital controls. This paper considers the benefit of re-introducing capital controls as a potential instrument of monetary policy in Kenya. This paper reviews the Kenyan experience with large capital inflows over the past 15 years (June 2000-June 2015). The findings revealed that capital inflow had positive effect on monetary policy in Kenya.

This paper argues that capital inflows that are not well absorbed by the private sector will cause financial instability under a fixed exchange rate regime. Whether capital inflows, particularly portfolio inflows, are good or bad as perceived by the recipient emerging market depends on how they are allocated and used. They can, if absorbed properly, contribute to a reduction in the cost of capital and to domestic capital formation and economic growth. On the other hand, they can also flood the domestic market, build up official reserves, and appreciate the real exchange rate. Moreover, they are very sensitive to political and economic shocks. Empirical analysis of Mexico's recent experience reveals that the capital influx into Mexico in the past decade did not contribute much to capital formation and economic growth. Instead, they were to a large degree absorbed by official reserves and imports for consumption. Capital inflows were a major factor in Mexico's real exchange rate appreciation. Capital flows in Mexico are found to be adversely affected by U.S. interest rates.

This paper analyzes the effects of changes in relative commodity prices on the distribution of income among factors of production in the context of two models of a simple, two-good economy. In the first model capital is treated as a specific factor in each industry, with labor mobile between industries. The assumption of specificity determines the direction of factor income changes, with magnitudes depending on substitutability between factors and on intensities of factor use within the two industries. In the second model, capital is viewed as a quasi-fixed factor. For the short run, this model is identical to the model first considered. For the long run, this model is identical to the Stolper-Samuelson model in which the direction and magnitude of factor income changes depend solely on relative factor intensities. The difference between the short-run and long-run determinants of changes in factor incomes gives rise to a conflict between factor owners' short-run and long-run interests.

The increasing cross‐border capital flows have raised the question of whether capital inflows and outflows have different impacts on exchange rates in emerging markets than they do in developed markets and economies. To explore the potential heterogeneity in the impacts that can arise from the different types and directions of capital flows, we classify them according to whether they involve foreign direct investment (FDI) or foreign portfolio investment (FPI) and examine these inflows and outflows separately. The characteristics of these different types of capital flows and their effects on the real exchange rate in both advanced and emerging markets during 2002–2017 are investigated using a set of estimation approaches. To capture the relationship between real exchange rates and capital flows while controlling for other variables, a dynamic panel data model is utilized for the dataset covering emerging countries. Key findings suggest that the composition of capital flows determines the impact of those flows on real exchange rates, whereby FPI brings a faster appreciation of the real exchange rate than FDI and capital outflows bring a sharper degree of exchange rate adjustment than capital inflows. F20F30.

This case was written as an exam case for first-year course, “Global Economies and Markets.” It is written as a comprehensive case that examines the policy choices facing a small open economy in an increasingly globalizing world. It can be used in a course on open economy macroeconomics or on international finance. Late in the day on December 18, 2006, the Bank of Thailand (BOT), the country's central bank, announced that effective the next day it would impose a 30% unremunerated reserve requirement (URR) on short-term capital inflows. The capital control measure required financial institutions to withhold in reserve accounts 30% of capital inflows that exceeded USD 20,000 for a period of one year. The restriction on capital inflows represented a significant escalation of Thailand's battle to stop the appreciation of its official currency, the baht (THB). On December 19, the Stock Exchange of Thailand (SET) composite index dropped by a record 14.84%, wiping out THB800 billion or USD22 billion of market capitalization. The sell-off affected regional stock markets as well, with Jakarta (Indonesia) down 2.85%; Kuala Lumpur (Malaysia) down 2%; and Singapore down 2.23%. In the foreign exchange market, the baht lost 2% of its value against the U.S. dollar to settle at about THB36 to the dollar. The large foreign capital inflows and the resulting appreciation of the Thai baht had culminated in the decision by the interim government to impose capital controls. The dramatic reactions in the financial markets, however, had prompted Thai policymakers to reevaluate the situation and to consider policy options for 2007.

Dealing with Capital Flows: Thailand in 2006

Recent episodes of excessive volatility in the foreign exchange market have brought to the fore the interest in studying the transmission mechanism of global uncertainty on the domestic economy. At the core is the degree of adjustment in the exchange rate as a shock absorber and the impacts of domestic policies in mitigating the spillover effects of global volatility. Using data for a sample of advanced and developing countries, the paper studies the responses of the nominal effective exchange rate, the real effective exchange rate, and price inflation to domestic and external sources of economic shifts. Subsequently, the analysis evaluates the degree of correlations between the responses of these variables to each economic shift. The objective is to study sources of movements in the real effective exchange rate and bilateral nominal exchange rates versus price inflation. The analysis then turns to evaluation of the determinants across countries of the time-series correlations between the change in the real effective exchange rate and its underlying components—nominal change and inflation—within countries over time. Cross-country regressions establish the relevance of the trend and variability of each of price inflation, the change in the nominal exchange rate, and the change in the real exchange rate on the degree of association between each pair. The evidence attests to a high pass-through from fluctuations in the nominal exchange rate to price inflation, which is more pronounced in developing countries, attesting to the need to target the real effective exchange rate as a framework for monetary policy.

This study aims to analyze the effect of macroeconomic variable shocks which include economic growth, real effective exchange rate, and world oil prices as a proxy for world price stability and monetary policy intervention through controlling the money supply against capital inflow in four ASEAN emerging market countries. This study uses a panel error correction model approach to fully utilize secondary data from 2000 to 2022 in Indonesia, Malaysia, the Philippines, and Thailand. The data is collected from the World Bank and Fred Economic Data. The results of this study indicate that monetary policy intervention through money supply control significantly influences capital inflows to ASEAN emerging market countries in the long run. Then, economic growth significantly affects capital inflows in ASEAN emerging market countries in the long run. Changes in oil prices and the real effective exchange rate do not significantly affect capital inflows in the long run. Economic growth significantly affects capital inflows in the short term. Meanwhile, monetary policy intervention, the real effective exchange rate, and the oil price did not significantly affect capital inflows in the short term in ASEAN emerging market countries. The results of this study show interesting findings because world oil prices, as the main indicator of changes in business and trade around the world, empirically show no significant effect on changes in capital inflows in emerging market countries. Meanwhile, monetary policy intervention effectively adjusts the balance of capital inflows in the long run. So it can be concluded that monetary policy in emerging market countries effectively controls long-term balance.

Global capital flows into emerging markets, including those in Asia, continue to be volatile. These capital flows generate both benefits and costs. The latter are associated with episodes of currency and banking crises like the 1997 Asian financial crisis and the 2008 global financial and economic crisis. Policy responses can be implemented to minimize the costs. At the same time, policy responses should vary depending on whether “pull” factors or “push” factors dominate the capital flows. Data show that the main impact of capital flows on economies of East Asia is reflected in real effective exchange rates, equity prices, and accumulation of foreign exchange reserves. If “pull” factors are dominant, policy makers should allow real exchange rates to appreciate in the long-term. Three broad categories of macroeconomic measures are available to countries facing surges of capital inflows, if they are not willing to allow the nominal exchange rate to appreciate: (i) sterilized intervention, (ii) greater exchange rate flexibility, and (iii) fiscal tightening (preferably through expenditure cuts). However, all of them have major drawbacks. Instead, capital controls or, more generally, macroprudential policy can be considered. Other policy recommendations include measures to encourage foreign direct investment, as this type of capital flow is more stable and beneficial; exchange rate coordination to reduce the adverse impacts of currency appreciation on the global competitiveness of domestic firms; and regional financial cooperation, particularly in the development of local bond markets. Recent data show the adverse impact of Quantitative Easing tapering on Asian economies. This is verified by econometric results showing the strong linkages between the United States bond markets and those in Asia. These findings enhance the role of macroprudential policy, which can be implemented in the context of regional cooperation in order to reduce negative spillovers across economies in Asia.

Mohan (2008) presents a comprehensive review of the macroeconomic policy developments in India over the past four decades with a particular emphasis on the last two decades. India transformed from a tightly controlled socialistic economy to one of the emerging market economies with accelerating growth. Before the transformation, the Indian economy was characterized by many regulations and controls, the nationalization of banks, and fiscal deficits that were financed by the central bank. The economy was in a low growth state, and the inflation rate was high. After the transformation, fiscal deficits have been reduced, and their direct financing by the central bank is banned. Monetary policy has been geared towards achieving a low and stable inflation rate. The critical regulatory changes took place after the balance of payments crisis of 1990 ‐1991. My comments are mostly directed to the current challenges rather than to India’s historical experience. The growth acceleration from 3% in the 1960s to 1980s, to 5% in the 1990s, to 8% after 2003, as shown in Mohan’s Table 1, is impressive, but still not perfect. It is impressive because it shows steady improvement as various reforms were taking place. It does not seem perfect because, first, the growth rate did not jump to a high range, say 8 ‐10%, immediately after the critical set of reforms in the beginning of the 1990s, and, second, in the near future, the growth rate does not seem likely to climb up to the 10% level that China has been able to achieve in the last decade. Why couldn’t India achieve doubledigit growth, if China could do it? The frustration is understandable but it may be important to recall some of the other growth experiences in Asia. Japan achieved double-digit growth in the 1950s and 1960s. South Korea, Taiwan, and Singapore achieved near 10% growth in the 1980s and 1990s. They all relied upon manufactured exports and climbed up the ladder of sophistication as they grew. Sustained 10% growth was possible only because those countries enjoyed export booms and their export items went from low-tech to middle-tech, and eventually to high-tech goods, as they chased the country just ahead of them. This view is known as the flying geese pattern of Asian growth. In a sense, 10% gross domestic product (GDP) growth was helped by very high (much higher than 10%) growth in the exports of toys and shoes followed by motorcycles and TVs, and then petrochemicals, steel, and automobiles.

In recent years, the importance of international capital flows has been increasing, which has significantly accelerated the integration process of the international financial system. After 2008, the central banks of major western developed economies implemented loose monetary policy, which led to a large amount of capital flowing into new market countries. However, international capital flowed out of new market countries after Federal Reserve Chairman Ben Bernanke said in 2013 that the Federal Reserve would gradually withdraw from quantitative easing.The great fluctuation of international capital has aroused the debate about monetary policy and macro-prudential policy. Rey (2015) believes that under any exchange rate system, only the control of international capital flows can maintain the independence of monetary policy. In view of the above findings, since 2016, the People’s Bank of China has established a macro-prudential regulatory mechanism for international capital flows to resist external financial shocks.By introducing domestic and international financial institutions, this paper brings the macro-prudential policy of foreign financial shocks and capital flows into the DSGE framework of small countries’ open economy. Domestic financial institutions can raise funds by absorbing the deposits of their own residents and foreign residents; international financial institutions buy and sell the creditor’s rights issued by various countries, so as to implement capital flows.It is found that under the impact of foreign interest rate increase, on the one hand, it will tighten the balance sheet of domestic financial institutions, and reduce the scale of corporate credit through bank incentives and constraints; on the other hand, it will cause the devaluation of domestic currency and international capital outflows, and affect the stability of the financial system. The macro-prudential management mechanism of capital flows can enhance the ability to resist external financial shocks. For China, the proportion of foreign debt is relatively low, and the policy effect is relatively mediocre for the counter cyclical tax adjustment mechanism of external borrowing of domestic financial structure; however, the counter cyclical adjustment mechanism for the capital flow of international financial institutions can significantly improve social welfare.This paper gives the following policy recommendations: Firstly, we should increase the significance of external financial risk prevention. In recent years, the rapid growth of international capital flows has brought new challenges to new economies. Secondly, we should strengthen the supervision of cross-border capital flows to resist external financial risks. In the process of further opening up of China’s financial market, the People’s Bank of China should improve the macro-prudential supervision of foreign exchange market, real estate market and credit market to prevent systemic financial risks. Finally, we should properly solve the financing problems of enterprises. For China, capital outflows will aggravate the already severe credit market pressure. Therefore, on the one hand, resist the external financial risk contagion through the macro-prudential supervision mechanism of capital flows; on the other hand, maintain the liquidity at a reasonable level through the flexible operation of monetary policy, in order to support economic growth.

Purpose– This study aims to analyze the spillover effects of external real and financial shocks on the Korean economy during January 2000 and December 2019. Design/methodology/approach–Using the Bayesian VAR model, we analyze whether there were substantial changes in the effects of U.S. monetary policy and macroeconomic shocks after the global financial crisis. Findings–First, an increase in U.S. industrial production had long-term positive effects on Korea’s real and financial variables, except for Korea’s call rate. Second, the U.S. monetary policy shock measured by an increase in federal fund rate had significant negative effects on Korea’s current account balance and stock prices. Third, the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) shock had a negative effect on Korea’s stock prices and the value of Korean won against the U.S. dollar. To sum it up, the spillover effects of external shocks have increased after the global financial crisis, implying that decoupling of domestic and foreign economies may be halted or reversed. Research implications or Originality– As the impact of the global financial crisis subsided and the global economy recovered, the spillover effects of external shocks on the domestic economy became also more significant. It should be noted that policy effectiveness may vary depending on interaction of internal and external economic conditions under the increasing uncertainty of the global economy.

Both policy makers and market participants have a strong interest in appropriate estimates of equilibrium real exchange rates and their prospective movements. They have also a keen interest in understanding determinants of the equilibrium real exchange rate and the factors behind implied misalignments of the actual rate from its equilibrium level. The real exchange rate is viewed as a key indicator of external competitiveness. Hence, a real appreciation of the exchange rate is often interpreted as a loss of price competitiveness. Nevertheless, this applies only if the real exchange rate becomes overvalued in relation to the equilibrium one. At the same time, real exchange rate appreciation can simply reflect improved competitiveness thanks to an increase in productivity. In this sense, the study of the determinants of the real exchange rates may shed some light on whether a real appreciation causes a loss in competitiveness or reflects the improvements in it (see also Frait and Komârek (1999, 2001)). The real exchange rate misalignments may be rather costly. Both overvalued and undervalued currencies have their negative implications. From policymakers' perspective, the risks implied by the overvaluation are more important. There is an empirical support for the view that an overvalued currency leads to lower economic growth, especially via the impact on the manufacturing (see e.g. Razin and Collins, 1997).KeywordsExchange RateReal Exchange RateNominal Exchange RateReal AppreciationEquilibrium Exchange RateThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.