Capital Mobility and Monetary Policy: An Overview

In both advanced and emerging economies, policymakers, academics, and the financial community were still trying to make sense of the financial tsunami that hit them in late 2008 and the channels through which the U.S. subprime mortgage crisis became viral and global almost synchronously. By 2011, the reverberations of the crisis in Europe were becoming clearer as the banking crises morphed into sovereign debt crises in a growing number of “periphery” countries (a group which now also includes Spain and Italy—in addition to Greece, Ireland and Portugal).1 The range of options under discussion for dealing with and solving the fiscal and lack of international competitiveness problems of countries in the periphery included discussions of the relative merits of the departure from (if not dissolution of) the euro. Emerging markets could not rely on history to provide a comparable turn of events to the Global Financial Crisis. At the height of the global crisis, capital flows to these countries predictably dried up overnight. Paradoxically, financial flows fled to the epicenter of the crisis (the United States) in search of safety (and/or liquidity). However, unlike other crisis episodes, the sudden stop did not last long for emerging markets and flows started to recover vigorously in the second half of 2009, largely unaffected by the problems in Europe. In effect, as the European periphery slid into a sovereign debt crisis of varying magnitudes and capital market access was lost, global investors in their eternal quest for higher yields increasingly saw emerging markets as the most attractive destination in an otherwise bleak global setting.