This chapter presents the recent Brazilian experience of dealing with capital inflows associated with domestic currency appreciation, and the use of macroprudential measures to cope with the capital surges. Restrictions on the financial account in Brazil are only some of the ingredients of the country’s economic policy, which includes controlling inflation along with maintaining a conventional monetary policy, as well as macroprudential measures, a fiscal consolidation program, a solid financial system, a focus on investment and infrastructure, and a very comprehensive income inequality-reduction policy.
The consequences of the 2008–2009 international financial turmoil have not yet come to an end, as the world is still waiting to see advanced economies addressing important financial and political problems. In the United States, the Federal Reserve has become the main source of economic stimulus, having implemented the third round of quantitative easing, with only partial and less than satisfactory results for the United States but with negative consequences for emerging economies.
In Europe, the crisis still persists, mainly in euro zone’s periphery, with severe economic and social consequences. Therefore, it is important that euro area countries come up with rapid and durable solutions, especially in terms of banking supervision and fiscal consolidation, so that economic growth picks up in the region. Since the fourth quarter of 2011, quarter-over-quarter economic growth in the euro area has been zero or below. European leaders are still struggling to find a solution that will put the region back on track.
In this particular circumstance, after establishing the monetary policy rates, central bankers in advanced economies began proposing a zero lower bound monetary policy that included aggressive quantitative easing. By 2013, more than US $9 trillion had been injected into the world’s liquidity, with part of this huge amount of money searching for very rare positive returns, mainly in emerging market (EM) economies. The unconventional monetary-easing policies consist of central bank purchases of domestic government bonds or even the provision of explicit guidance on the future path of interest rates, with medium-term inflation or nominal output and unemployment rates as targets.
As a rational response, Brazilian monetary authorities have put into practice macroprudential measures that include restrictions on the capital accounts. Roughly speaking, these measures consist of increases in IOF (a tax on financial transactions) rates on short-term financial operations, including external loans up to one year, with the main aim being to reduce gains in carry-trade strategies. Foreign direct investments and even long-term financial operations are left aside.
This chapter highlights the fact that managing capital inflows is only part of the policy mix. Such a strategy has been effective in dealing with the increasing international liquidity and in preventing inflows of very short-term foreign capital, as well as in changing the composition of capital inflows toward better-quality capital inflows. Therefore, the exchange rate staunched its appreciation movement and since then has been less volatile. It is also worth noting that the interest rate may have increasing power to affect the exchange rate under such a policy.
We know how controversial the role and the effectiveness of capital controls are during crises. However, there has been a distinct scenario since 2008 suggesting that countries such as Brazil should care about its exchange rate and quality of capital surges. A combination of a zero lower bound monetary policy with quantitative easing, provoking exchange rate realignments across the world, is treated as part of the solution to the fragilities in advanced economies, but at the same time, it represents sizable constraints on EM economies. We are definitely in a noncooperative, non-zero-sum game, and thus EM economies are being harmed rather than benefited. Capital account management measures are a technical rather than an ideological issue. They join the policy toolkit, with successful results.
In the next section I examine the economic literature on capital controls and then describe the recent Brazilian experience.
The Literature
Several recent studies have reviewed the role played by capital controls in the context of a world economy emerging from a financial crisis. Even the IMF (2012) in its “institutional view” on capital controls suggests some signs of progress on the matter. The analysis of Ostry and others (2010) can be considered one of the first in the new context. They discuss not only the benefit of the capital inflows into emerging markets but also the appropriate policy responses. Baba and Kokenyne (2011) estimate the effectiveness of capital control in response to inflow surges in EMs such as Brazil, Colombia, Korea, and Thailand in the 2000s.
It is fair to say that the globalization of capital markets has been beneficial when it allows capital flows to move toward their most attractive destination, but at the same time this process has been associated with episodes of dramatic financial crises. In this scenario, there is an incipient debate regarding the role of international capital flows in triggering such crises, and if that is the case, capital controls become an important policy tool to be used by EM countries, as happened quite often during the 1990s.
Recently, a number of studies have argued that free capital mobility has created a highly unstable international financial system and that developing countries need to manage capital flows. It is important to note that this idea is not a new one and dates back to James Tobin (1978), who argued that reducing macroeconomic instability would require the adoption of a global tax on foreign exchange transactions to reduce speculation in international financial markets.
The rationale for imposing restrictions (capital controls) on international capital flows is associated with the belief that capital markets are usually characterized by market failures and distortions (information asymmetry), and that such imperfections are magnified by difficulties in enforcing contracts across borders and by a kind of herd behavior, such as when investors overreact to external shocks.
One of the reasons most often voiced in the defense of using capital controls during periods of crises is that it allows the central bank to stem the drain on foreign exchange reserves and that monetary authorities could initially raise interest rates; once capital controls are in place, it gives room for a lower and more stable interest rate, which acts in a procyclical way. It is also important to note that capital controls introduce a wedge between domestic and foreign interest rates, and the domestic interest rate policy does not need to follow international interest rates when facing the consequences of international crises and the breakdown of uncovered interest parity.
The discussion of some policy issues regarding the effectiveness of imposing capital controls should be carried out with the understanding of the required steps (sequencing reform) toward the liberalization of the capital account. The main issue is not whether or not capital controls should be eliminated but under what conditions (when and how fast) they would be effective in achieving desirable economic outcomes. Most countries’ experiences with capital controls have shown that the private sector found ways of getting around capital controls, usually adopting strategies based on overinvoicing (underinvoicing) imports (exports) and mislabeling the nature of capital movements (short-term portfolio flows labeled as trade credit).
The majority of the studies have argued that before liberalizing the capital accounts, it is necessary to reverse major fiscal imbalances and achieve macroeconomic stability. The past experience of many developing countries, including Brazil in the 1990s, has shown that although price stability was obtained, it was still necessary to implement fiscal reforms to improve the overall macroeconomic fundamentals of the economy. Other than this, establishing a sound banking system is also necessary before developing countries can lift restrictions on capital mobility, as banks will intermediate the inflows of capital, which should not happen in an inefficient way.
Previous works, such as those by Reinhart and Smith (2002) and Kaminsky and Schmukler (2001), examined the role of temporary controls on capital inflows, emphasizing that capital controls have two crucial features: they are asymmetric (the target is capital inflows rather than capital outflows) and temporary. The authors examined possible reasons for policymakers to adopt controls on capital inflows and two types of shocks that can result in excessive capital inflows (temporary changes in the foreign interest rate and in domestic monetary policy). The major empirical findings are that the tax rate on capital inflows should be very high to affect the capital account balance, that the economic benefit of taxing capital inflows is not significant, and that taking too long to remove capital controls can reverse welfare benefits.
Malaysia and Thailand are two EM countries making use of capital controls during episodes of financial crises in the recent past; the experiences of those countries were examined by Edison and Reinhart (2001). Their main empirical findings suggest that capital controls help reduce interest rate volatility but there is mixed evidence for avoiding exchange rate volatility. Another important finding refers to a wider and more variable bid-ask spread during control periods, and little evidence that capital controls were effective in reducing volatility spillovers.
Kaminsky and Schmukler (2001) dealt with the question of whether or not capital controls affect the link between domestic and foreign stock market prices and interest rates—in other words, whether they matter for international market integration. The authors found little evidence that capital controls can segment domestic and foreign markets, and even when they do, the effects do not last long. Finally, they found that it is difficult to distinguish the effects of controls on inflows and outflows.
The Chilean experience during the 1990s has been examined in detail by De Gregorio, Edwards, and Valdes (2000), who developed work that addressed the issue of whether or not controls on capital inflows are efficient through the use of unremunerated reserve requirement. They also examined the effects on interest rates, the volume and composition of capital inflows, and the real exchange rate. Their main empirical findings suggest that it is difficult to find long-run effects, and that capital controls generate an increase in the interest rate differential only in the short run, no effects on the real exchange rate, and a significant effect in the composition of capital inflows in favor of a longer maturity.
Another study linked to the Chilean experience with controls on inflows and outflows of capital during the 1990s was reported by Edwards (1999), and the empirical results suggest that controls on outflows are not effective, whereas controls on inflows have the advantage of affecting the maturity of foreign debt, which is a desirable outcome for the monetary authorities. The three main goals of Chile’s capital controls were to slow down the inflow of capital and change its composition toward capital of longer maturities, to reduce and postpone real exchange rate appreciation, and to help the monetary authorities adopt an independent monetary policy (maintaining an interest rate differential). The author also found that controls on capital inflows are not sufficient to eliminate financial instability. The GARCH—generalized autoregressive conditional heteroskedasticity—estimation reveals that the restrictions on capital inflows were successful in reducing stock market instability, but not short-run interest rate volatility.
Generally, the discussion about the effects of restrictions on capital inflows has shown that controls are important to explaining changes in the composition of capital flows in the direction intended (reducing the share of short-term and portfolio flows, and increasing foreign direct investment). The literature addresses the issue of whether external factors (international interest rates and liquidity) or internal factors (domestic fundamentals) are more important to explaining the increase in the financial flows to emerging economies, and relate this to the question of how these countries respond to an increase in capital flows.
The empirical evidence has indicated that capital inflow is more volatile in Latin America than in Asia, and short-term capital is more volatile than all other types of capital flows. The adoption of sterilized intervention increases the volume of total capital flows through short-term capital, and capital controls have no significant effect on reducing the overall volume of flows, but they affect the composition of capital flows in favor of foreign direct investments. Finally, short-term flows are not sensitive to changes in international interest rates, although the composition of capital flows does respond to such changes.
After the 2008 financial crisis, as some important economies reestablished restrictions on their financial capital account as part of the policy toolkit, academics, policymakers, and international institutions alike have been trying to shed new light on such controversial issues. Thus, we next present Brazilian recent practices and policy responses in the context of the crisis.
The Brazilian Experience
First, it is important to distinguish the current global scenario from that faced by Latin American economies in the 1990s. At that time, it was observed that the liquidity curb was more related to weak domestic macroeconomic fundaments in such economies than to international pressures caused by central banks in advanced economies. Financial and currency crises associated with debt defaults used to be commonplace in the developing world. Those crises were usually explained either by wrong domestic economic policies (crazy policymakers in the developing economies) or by wrong economic agents (crazy agents under self-fulfilling features). Asian crises were explained by wrong markets, to the result of contagious and herd behaviors (see Frankel and Wei 2004).
On the other hand, according to the IMF (2012, 6), “Capital flow liberalization has been part of the development strategy in several countries, in recognition of the benefits that such flows can bring.” Actually, it is a novel strategy associated with unconventional monetary policies developed by the central economies trying to resume growth. That denotes a very different nature of capital flow surges experienced nowadays in comparison with past practices. It is “liquidity injection” rather than “capital flows liberalization,” usually parsed as “removal of restrictions.”
This distinction makes quite a difference to policy recommendations, especially with respect to how EM economies should deal with it. It is also not a matter of “unrestricted convertibility of local currency in international financial transactions.” (IMF 2012, 10) It seems that the recent capital surges are more associated with the less convertible currencies combating devaluation in international currencies.
The relationship between growth and the exchange rate (devaluations, misalignments, and volatilities) has been approached in the economic literature from different perspectives.1 It is still a controversial topic, though it is fair to state that devaluations foster growth through different channels, mainly the trade one. Weak domestic markets in advanced economies result in an excessive inventory of manufactured goods searching for international markets; thus, devaluation would be very helpful.
Under such specific circumstance, the capital flow management measures put forward in EM economies are a rational response, and as beneficial as they are prudential.
The current context for implementing capital controls is quite different. Currently, problems are caused by crazy policymakers in advanced economies. Unconventional monetary policy—including rude quantitative easing programs under a zero lower bound monetary policy—has been urged by central banks in advanced economies. Figures 24.1 and 24.2 show how sizable the expansion of international liquidity is as a result of this practice.
Expansion of International Liquidity
(US $ trillion).
Notes: European Central Bank; Bank of Japan; Bank of England.Source: Bloomberg, http://www.bloomberg.com.Expansion of International Liquidity
(US $ trillion).
Notes: European Central Bank; Bank of Japan; Bank of England.Source: Bloomberg, http://www.bloomberg.com.Expansion of International Liquidity
(US $ trillion).
Notes: European Central Bank; Bank of Japan; Bank of England.Source: Bloomberg, http://www.bloomberg.com.
Expansion of the Monetary Base in Advanced Economies, 2007–2014
(US $ billion).
Note: * Bank of Japan estimated in April 2013.Source: Bloomberg.Expansion of the Monetary Base in Advanced Economies, 2007–2014
(US $ billion).
Note: * Bank of Japan estimated in April 2013.Source: Bloomberg.Expansion of the Monetary Base in Advanced Economies, 2007–2014
(US $ billion).
Note: * Bank of Japan estimated in April 2013.Source: Bloomberg.As can be seen from these figures, central bankers in advanced economies, such as the United States, Europe, and Japan, have introduced very aggressive expansionary monetary policies. Notwithstanding the benefits of such monetary stances, EM countries are concerned that the surge in capital inflows could cause problems for their economies. Exchange rate appreciation, reserve accumulation with some fiscal costs, and incentives to excessively borrow abroad, risking a domestic credit boom, are only some consequences that have recently been observed. It should be added that the international interest rates are pretty low and have remained so for a long period of time, especially in comparison with normal interest rate levels in EM economies, which constitutes an incentive to make loans abroad in international currencies. It can also amplify currency mismatches, with the well-known propensity for instability in EMs during a sudden cessation of capital flows, sometimes leading to unexpected exchange rate devaluations.
In the Brazilian case, an increase in international liquidity created excessive pressure on the exchange rate. Consequently, the economic authorities created a transaction tax (IOF) on new capital flows. Table 24.1 shows the evolution of the IOF on portfolio investments and external loans, which can be summarized as follows (observations to June 2013):
Brazil: Tax on Financial Transactions, 2008–2013 (%)
Brazil: Tax on Financial Transactions, 2008–2013 (%)
| December | October | October | October | July | December | February | March | June | December | June | June | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 3, 2008 | 19,2009 | 4, 2010 | 18,2010 | 26, 2011 | 1,2011 | 29,2012 | 9,2012 | 13,2012 | 4, 2012 | 4, 2013 | 12, 2013 | |
| Portfolio: | ||||||||||||
| Fixed income | 1.50 | 2.00 | 4.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 0.00 | 0.00 |
| Long-term corporate bonds | 1.50 | 2.00 | 4.00 | 6.00 | 6.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Equity | 0.00 | 2.00 | 2.00 | 2.00 | 2.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Derivative margin deposit | 0.38 | 0.38 | 0.38 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 0.00 | 0.00 |
| External loan up to: | ||||||||||||
| 90 days | 5.38 | 5.38 | 5.38 | 5.38 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 |
| 270 days | 0.38 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 |
| 1 year | 0.38 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 |
| 2 years | 0.38 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 0.00 | 0.00 | 0.00 |
| 3 years | 0.38 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| 5 years | 0.38 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 6.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Excessive long positions on BRL | 0.00 | 0.00 | 0.00 | 0.00 | 1.00 | 1.00 | 1.00 | 1.00 | 1.00 | 1.00 | 1.00 | 0.00 |
Brazil: Tax on Financial Transactions, 2008–2013 (%)
| December | October | October | October | July | December | February | March | June | December | June | June | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 3, 2008 | 19,2009 | 4, 2010 | 18,2010 | 26, 2011 | 1,2011 | 29,2012 | 9,2012 | 13,2012 | 4, 2012 | 4, 2013 | 12, 2013 | |
| Portfolio: | ||||||||||||
| Fixed income | 1.50 | 2.00 | 4.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 0.00 | 0.00 |
| Long-term corporate bonds | 1.50 | 2.00 | 4.00 | 6.00 | 6.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Equity | 0.00 | 2.00 | 2.00 | 2.00 | 2.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Derivative margin deposit | 0.38 | 0.38 | 0.38 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 0.00 | 0.00 |
| External loan up to: | ||||||||||||
| 90 days | 5.38 | 5.38 | 5.38 | 5.38 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 |
| 270 days | 0.38 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 |
| 1 year | 0.38 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 |
| 2 years | 0.38 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 6.00 | 6.00 | 6.00 | 0.00 | 0.00 | 0.00 |
| 3 years | 0.38 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 6.00 | 6.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| 5 years | 0.38 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 6.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Excessive long positions on BRL | 0.00 | 0.00 | 0.00 | 0.00 | 1.00 | 1.00 | 1.00 | 1.00 | 1.00 | 1.00 | 1.00 | 0.00 |
1. Portfolio investments include fixed income and derivatives. They were all taxed at a 6 percent rate, with exception of capex and infrastructure bonds (there has never been an IOF on external flows to these bonds). Also, an IOF has not been applied to equities.
2. Short-term (up to one-year) inbound loans and offshore bond issues (overseas debt) are subject to an IOF at a rate of 6 percent.
3. There has not been a 1 percent IOF tax on foreign exchange short positions held by banks, funds, and companies.
It is worth noting that when it became necessary to do so, the Brazilian authority promptly withdrew such measures, indicating that they are additional tools to manage capital flows. That was the case observed in June 2013, when the IOF applied to portfolio investments, including fixed income instruments and derivatives, was reduced to zero.
The appreciation path of the Brazilian exchange rate was interrupted by the financial crisis of September 2008, which was reversed with the quantitative easing monetary policies adopted by developed economies. To reduce the vulnerability and procyclicality of capital flows, Brazil introduced measures to manage its capital account through prudential regulation. These measures are also illustrated over the time in figure 24.3. From this figure it is possible to infer that after controls on surges of capital inflows were initiated, the Brazilian real realized an appreciation and moved to a new stable equilibrium.
As can be seen in figure 24.3, the effectiveness of the restrictions on capital control has been longer than expected by the economic literature. Results include a more stable exchange rate and less vulnerable balance sheets, both in domestic companies and in the financial system. There are some plausible explanations for such successes.
First, the Brazilian economy is much less dollarized than it was a decade ago. The dollarization of an economy is strongly associated with both current inflation and inflation risk.2 It is a rational response of agents to deal with inflation. As inflation and the risks of high inflation have decreased substantially in Brazil, along with sovereign risks, currency mismatches in balance sheets have shown a sizable reduction. As a result, capital account management measures do not change foreign investors’ perceptions about the country.
Second, the composition of the capital inflows changed very clearly after restrictions were placed on short-term financial inflows. As described in the literature, restrictions on capital flows play an important role in capital allocation, changing the composition of capital inflows in favor of foreign direct investments. In Brazil, foreign direct investment has been as high as it was before the restrictions were placed on capital inflows. Meanwhile, as the returns on the carry-trade strategy turned out to be negative (see figures 24.4 and 24.5), short-term capital inflows have been reduced.
Returns on Carry-Trade Strategies in Selected Countries, 2008 and 2013
(%, 12-month accumulated).
a. June 2008.b. June 2013.Source: Bloomberg.Returns on Carry-Trade Strategies in Selected Countries, 2008 and 2013
(%, 12-month accumulated).
a. June 2008.b. June 2013.Source: Bloomberg.Returns on Carry-Trade Strategies in Selected Countries, 2008 and 2013
(%, 12-month accumulated).
a. June 2008.b. June 2013.Source: Bloomberg.
As shown in figure 24.6, long-term capital inflows remain stable at a very high level, while portfolio investment has decreased toward a level not seen since before the 2008–2009 financial crisis. Neither intercompany transactions nor equity have been affected by such measures.
Brazil: Foreign Direct Investment, 2008–2013.
Source: Central Bank of Brazil.Brazil: Foreign Direct Investment, 2008–2013.
Source: Central Bank of Brazil.Brazil: Foreign Direct Investment, 2008–2013.
Source: Central Bank of Brazil.Third, Brazil has put forward a set of macroprudential policies, including capital account management, along with conventional monetary policy. Consistent fiscal results have been accomplished; thus, the ratio of public debt to GDP has decreased very quickly. In addition, Brazil has left behind any probability of fiscal insolvency. The international investor’s confidence in the Brazilian sovereign bonds has increased, as shown in figure 24.8. According to this figure, the difference between the yields on 10-year Brazilian and US bonds has narrowed consistently since 2011. A commitment to fiscal responsibility throughout the years, combined with economic growth, has contributed to a reduction in credit risk in Brazil.
Yield* on 10-year Brazilian and US Bonds, 1999–2013 (%).
Notes: *Measured by the difference in yields on issue date on 10-year Brazilian bonds denominated in US dollars and yields on US Treasury bonds (same maturity) traded on the secondary market on the same date. ** From October 2012, yields on 10-year Brazilian and US Treasury bonds (same maturity) traded on the secondary market on the same date.Source: Ministry of Finance, Brazil, and Bloomberg.Yield* on 10-year Brazilian and US Bonds, 1999–2013 (%).
Notes: *Measured by the difference in yields on issue date on 10-year Brazilian bonds denominated in US dollars and yields on US Treasury bonds (same maturity) traded on the secondary market on the same date. ** From October 2012, yields on 10-year Brazilian and US Treasury bonds (same maturity) traded on the secondary market on the same date.Source: Ministry of Finance, Brazil, and Bloomberg.Yield* on 10-year Brazilian and US Bonds, 1999–2013 (%).
Notes: *Measured by the difference in yields on issue date on 10-year Brazilian bonds denominated in US dollars and yields on US Treasury bonds (same maturity) traded on the secondary market on the same date. ** From October 2012, yields on 10-year Brazilian and US Treasury bonds (same maturity) traded on the secondary market on the same date.Source: Ministry of Finance, Brazil, and Bloomberg.Finally, the medium-term growth prospect also plays an important role, encouraging the foreign direct investments to search for opportunities, and Brazil today is one of the best countries in the world in which to invest. The Brazilian government has just launched a comprehensive program of concessions in the infrastructure sector, including airports, ports, railways, high-speed trains, oil, gas, and electricity, for a total amount of US $235 billion. It is just the first step toward addressing the entire spectrum of the country’s infrastructure needs. Many investment projects in different sectors, such as in automobile, chemistry, health care, and others, are being set up. As a middle-class society, Brazil has a dynamic domestic market with a low unemployment rate and lower income inequalities. It seems that growth prospects and investment opportunities matter to foreign investors more than restrictions in short-term capital inflows do.
Summary
Excessive international liquidity has provoked side effects in EM economies, and Brazil is more a rule than an exception among them. To cope with the effect of unconventional monetary policies implemented by advanced economies’ central banks, Brazil has introduced a set of macroprudential policies that includes capital account management, along with conventional monetary policy. Capital account management is much more a technical issue than an ideological one. Successful results have been obtained under the circumstances. The economic policy stance includes measures to foster investments in the context of inflation under control, a growth-friendly fiscal consolidation program, a solid financial system, and strong income-inequality reduction.
After restrictions on the country’s financial account were implemented, the Brazilian real appreciated, moving upward until it stabilized at the parity of 2 reals per US dollar. It is fair to say that the effectiveness of the controls, begun in 2011, has lasted longer than expected. The benefits of the controls are generally greater than the eventual costs. As such measures are also prudential, borrowing abroad in other currency has been less leveraged.
Notes
See Holland and others (2013) for new empirical findings on the relationship between growth and exchange rate volatility. According to these authors, it seems that exchange rate volatility matters to growth more than misalignment does.
Financial dollarization is a topic associated with high inflation and inflation risk in Latin American economies, and Vieira, Holland, and Resende (2012) have associated such phenomena with sovereign risks as dollarization remains high, even after inflation and inflation risk decrease.
References
Baba, C., and A. Kokenyne. 2011. “Effectiveness of Capital Controls in Selected Emerging Markets in the 2000s.” IMF Working Paper 11/281, International Monetary Fund, Washington, DC.
De Gregorio, J., S. Edwards, and R. O. Valdes. 2000. “Controls on Capital Inflows: Do They Work?” NBER Working Paper 7645, National Bureau of Economic Research, Cambridge, MA, April.
Edison, H., and C. M. Reinhart. 2001. “Stopping Hot Money.” Journal of Development Economics 66 (2): 533–553.
Edwards, S. 1999. “How Effective Are Capital Controls?” Journal of Economic Perspectives 13 (4): 65–84.
Frankel, J., and Shang-Jin Wei. 2004. “Managing Macroeconomic Crises: Policy Lessons.” Manuscript, Harvard University, Cambridge, MA.
Holland, M., F. V. Vieira, C. Gomes da Silva, and L. C. Bottecchia. 2013. “Growth and Exchange Rate Volatility: A Panel Data Analysis.” Applied Economics 45(26): 3733–3741.
International Monetary Fund (IMF). 2012. “The Liberalization and Management of Capital Flows: An Institutional View.” International Monetary Fund, Washington, DC, November 14. http://www.imf.org/external/np/pp/eng/2012/111412.pdf.
Kaminsky, G. L., and S. Schmukler. 2001. “Short- and Long-Run Integration: Do Capital Controls Matter?” Policy Research Working Paper 2660, World Bank, Washington, DC.
Ostry, Jonathan D., Atish R. Ghosh, Karl Habermeier, Marcos Chamon, Mahvash S. Qureshi, and Denis B. S. Reinhardt. 2010. “Capital Inflows: The Role of Controls.” IMF Staff Position Note 10/04, International Monetary Fund, Washington, DC, February 19. http://www.imf.org/external/pubs/ft/spn/2010/spn1004.pdf.
Reinhart, C. M., and R. T. Smith. 2002. “Temporary Controls on Capital Inflows.” Journal of International Economics 57 (2): 327–351.
Tobin, J. 1978. A Proposal for International Monetary Reform. Eastern Economic Journal 4 (3/4): 153–159.
Vieira, F A. C., M. Holland, and M. F. Resende. 2012. Financial Dollarization and Systemic Risks: New Empirical Evidence. Journal of International Money and Finance 31 (6): 1695–1714.
