Managing the Exchange Rate in the Face of Volatile Capital Flows

Emerging market economies (EMEs) face continuing challenges in managing boom-bust capital flow cycles. Flows have become increasingly volatile, putting upward pressures on currencies during the boom, and creating dislocations during the bust. During 2008, flows to EMEs, which had peaked at $665 billion the previous year, plummeted to less than $170 billion, only to surge again in 2010 as the global recovery got underway. Following the US sovereign downgrade, capital flows to EMEs again dried up, then resumed, and they have been bouncing around quite a bit ever since. This volatility, moreover, is unlikely to be the exclusive result of country-specific factors in the recipient countries (pull factors), but likely reflects global forces to a significant degree, including the changing monetary policy in major source countries and risk-on-risk-off considerations. Debates have ensued about how emerging market countries should manage this capital flow volatility.