This paper examines whether—and how—emerging market economies (EMEs) respond
to capital flows to mitigate their untoward consequences. Based on a sample of about 50
EMEs over 2005Q1–2013Q4, we find that EME policy makers respond proactively to
capital inflows by using a combination of policy tools: central banks raise the policy
interest rate to address economic overheating concerns; intervene in the foreign exchange
market to resist currency appreciation pressures; tighten macroprudential measures to
dampen credit growth; and deploy capital inflow controls in the face of competitiveness
and financial-stability concerns. Contrary to conventional policy advice to EMEs, we find
no evidence of counter-cyclical fiscal policy in the face of capital inflows. Overall,
policies are more likely to respond, and used in combination, during inflow surges than in
more normal times.
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