Description

The last few years have brought unprecedented challenges to macroeconomic management in small, open economies. After the inflationary shock and the crisis, new challenges have emerged. Particularly, emerging market economies are currently experiencing a robust recovery, which can give rise to capital inflows. This document discusses current developments and the appropriate policies to deal with capital inflows. It is argued that the first line of defense is exchange rate flexibility within a context of monetary policy that focuses on price stability. Foreign exchange intervention can be used exceptionally. Additional measures, such as capital controls, cannot be a priori ruled out, and will be specific to each economy, but it is important to recognize that in financially integrated economies its effectiveness is limited. It is additionally argued that these exceptional measures cannot be a substitute for good macroeconomic management and appropriate regulation of the financial system.