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Subject 7. Exchange Rate Management: Intervention and Controls PDF Download
Surges in capital inflows are often driven by a combination of push and pull factors. Pull factors are those that attract capital from abroad as a result of improvements in the risk-return characteristics of assets in developing countries, while push factors are those operate by reducing the attractiveness of investing in developed country assets.

Unwanted capital inflows can harm an economy if they fuel boom-like conditions, create asset bubbles and overvalued currency. Once the trend is reversed it usually results in a major economic downturn.

The key question for emerging market (EM) policymakers is how to respond to an unwanted surge in capital inflows. The International Monetary Fund offers the following guidelines:

  • If the EM currency is undervalued, allow it to appreciate appropriately.
  • If there is no inflation threat, central banks should engage in unsterilized intervention which will expand the monetary base and reduce short-term interest rates.
  • If inflation is a concern, the intervention should be sterilized - this requires offsetting intervention with the buying or selling of government bonds.
  • The final line of resistance is capital controls.

The evidence indicates that intervention by industrial countries has had an insignificant impact on the course of exchange rates. The evidence is more mixed for emerging markets.

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