Capital Account Regulations and Macroeconomic Policy: Two Latin American Experiences

Levy Economics Institute WP #162

Posted: 10 Jul 1997

Date Written: May 1996


A resurgence of perceived opportunities by international investors has resulted in a new policy debate regarding the regulation of capital flows into certain South American countries. The integrationist camp defends totally open markets on the grounds that they result in a more efficient financial sector, greater asset diversification, and other benefits, while those in the isolationist camp support regulating capital inflows on the grounds that they generate macroeconomic instability and reduce the effectiveness of monetary policy. Noting that there are both costs and benefits associated with external capital flows, Guillermo Le Fort V., international director of the Central Bank of Chile, and Carlos Budnevich L., manager of financial analysis for the Central Bank of Chile, argue against both extremes, opting instead for a policy falling somewhere between the two. An intermediate policy of gradual and limited financial integration has been adopted in Chile and Colombia, two countries experiencing capital account surpluses. Le Fort and Budnevich examine the macroeconomic and financial results during the 1990s of the countries' policies regarding external capital accounts. In the early 1980s the Chilean financial system was wracked by insolvency that was deepened by recession. By 1983 volatile international capital inflows, resulting from the removal of restrictions to such flows, had precipitated a widespread crisis. Having weathered this experience, Chile's financial institutions are cautious and concerned about maintaining moderate current account deficits. Policies to accomplish this goal include a targeted range for the medium-term current account deficit, foreign exchange market and capital account regulations, and a limit to the degree of integration of external and domestic markets. The authors note, however, that the reserve requirement cannot stem currency appreciation, which has averaged about 4 percent per year. They also conclude that capital account regulations have not impaired the financial system. "In fact, despite the regulations, the financial system and the capital markets have achieved very significant development in Chile over the past few years." In contrast to Chile's experience, Colombia's financial sector reforms were structural in nature, taking the form of opening the economy to additional international trade through the elimination of administrative restrictions to imports and a generalized reduction of tariffs, subscribing to bilateral international trade agreements with other Latin American countries, implementing measures to increase the exchange rate's flexibility, removing restrictions on external investment, cutting the overall tax rate, liberalizing the labor market, privatizing various public enterprises including the social security system, and legalizing the independence of the central bank. At the beginning of the 1990s Colombia began to experience a large inflow of international reserves, but recently this trend has changed, causing the current account to move from surplus to deficit. Does the change in the capital account imply that the reforms have failed? Le Fort and Budnevich reject the argument that the new capital account trend was driven by capital flows and attribute it to an import boom (brought on by trade liberalization) and a sudden adjustment of the stock of durable consumption goods. They also note that the composition of the current account has changed, with foreign direct investment rising steadily, short-term debt fluctuating around zero, and debt flows rising from 1 percent to 5 percent of GDP. Moreover, exchange rates reflect economic fundamentals; the domestic budget has been in balance or surplus; and the economy has grown at a moderate to slightly elevated rate. However, inflation has remained a chronic problem, persisting at 20 to 25 percent. The authors attribute this performance to effective capital controls, arguing that even in an economy with high domestic interest rates and low disposable income, public debt has remained relatively low. Moreover, despite steady inflation and a noninterventionist, crawling-peg exchange rate system, the foreign exchange market has not experienced undue pressure. Le Fort and Budnevich conclude that the economic performance of Colombia and Chile in the 1990s has been good compared to their historical performance and performance in other countries in their region. The authors credit reserve requirement and other capital account regulations as playing an important role in this success. Consistent macroeconomic policies and microeconomic incentives are, of course, the main reasons behind the economic achievements of these two countries.

JEL Classification: F21, F33, F41

Suggested Citation

Le Fort, Guillermo and Budnevich, Carlos, Capital Account Regulations and Macroeconomic Policy: Two Latin American Experiences (May 1996). Levy Economics Institute WP #162. Available at SSRN:

Guillermo Le Fort (Contact Author)

Bard College

Annandale-on-Hudson, NY 12504
United States
845-758-7700 (Phone)
845-758-1149 (Fax)

Carlos Budnevich

Bard College

Annandale-on-Hudson, NY 12504
United States

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