Abstract
In this article, we evaluate the effectiveness of policy measures adopted by Chile and Colombia aiming to mitigate the deleterious effects of pro-cyclical capital flows. In the case of Chile, according to our GMM analysis, capital controls succeeded in reducing net short-term capital flows, but did not affect long-term flows. As far as Colombia is concerned, the regulations were capable of affecting total flows and also long-term ones. In addition, our cointegration models indicate that the regulations did not have a direct effect on the real exchange rate in the Chilean case. Nonetheless, the model used for Colombia did detect a direct impact of the capital controls on the real exchange rate. Therefore, our results do not seem to support the idea that those regulations were easily evaded.
Highlights
The excessive liquidity in international capital markets during the 1990s posed several challenges to policymakers in emerging economies
We present evidence from Generalized Method of Moments (GMM) regressions and Vector Error Correction models (VECM) in order to assess the effects of the price-based capital controls on capital flows and on the real exchange rate
There is evidence that the controls on capital inflows reduced total net capital flows in the case of Chile; they do not seem to have affected long-term capital flows in this country
Summary
The excessive liquidity in international capital markets during the 1990s posed several challenges to policymakers in emerging economies. Problems associated with moral hazard, fragility in financial intermediaries’ and corporate balance sheets, asset price bubbles, consumption booms and real exchange rate overvaluation were intimately connected to the boom-bust cycle in international capital flows to developing countries following the financial liberalization process In this context, it became evident that full capital account openness can be associated with increased macroeconomic volatility and limitations in degrees of freedom for domestic policy makers, when capital flows are strongly pro-cyclical. Our interest at present lies in examining the imposition of price-based capital account management polices in Chile and Colombia since the early 1990s The aims of those regulations included reducing the costs of sterilization policies and the appreciation of the real exchange rate associated with large capital inflows and increasing the autonomy of domestic monetary policy.
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