Macroeconomic adjustment to capital inflows: Lessons from recent Latin American and East Asian experience

Abstract

Capital inflows to some developing countries have increased sharply in recent years. Impelled by better economic prospects in those countries, lower international interest rates, and a slowdown of economic activity in the capital-exporting countries, the inflows have furnished financing much needed to increase the use of existing capacity and to stimulate investment. But capital inflows can bring with them their own problems. Typical macroeconomic repercussions have been appreciation of the real exchange rate, expansion of nontradables at the expense of tradables, larger trade deficits, and, in regimes with a fixed exchange rate, higher inflation and an accumulation of foreign reserves.

Should government intervene to limit some of these side effects-and if so, how? The question is especially pressing in the wake of the Mexican crisis of December 1994. This article looks for answers in the experience of four Latin American and five Last Asian countries between 1986 and 1993, examining the effects of the capital inflows on the economy and comparing the different ways in which these countries responded to the problem of ''too much'' capital.