Implications of a Surge in Capital Inflows: Available tools and Consequences for the Conduct of Monetary Policy

IMF Working Papers, May 1, 1996

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The paper extends discussion of monetary policy instruments to the situation of a country faced with major capital inflows when domestic financial liberalization is incomplete.
It:
- briefly summarizes the recent usage of traditional monetary instruments;
- discusses the practical limits to classic sterilization measures;
- discusses the pros and cons of using other supplementary measures including tax-based controls on capital inflows;
- examines the efficacy of such measures in Chile, Colombia, Indonesia, Korea, Spain, and Thailand.
Conclusion: for a time and as a transitional measure, a country may find it opportune to supplement traditional instruments with certain “belt and braces” measures including, in some instances, indirect (tax-based) capital controls.

Practical limits to classic sterilization measures are highlighted, particularly in the context of incomplete domestic financial liberalization.
Tax-based (indirect) capital controls are evaluated as supplementary tools, with attention to their pros and cons.
Efficacy of instruments is assessed through cross-country examination (Chile, Colombia, Indonesia, Korea, Spain, Thailand).

Temporary, transitional use of supplementary measures can be opportune when facing major capital inflows and incomplete financial liberalization.
Supplementation of traditional monetary instruments with “belt and braces” measures, including in some instances indirect (tax-based) capital controls, is a recommended option for a time.