Yellen defends IMF proposals on capital controls

Federal Reserve vice-chair takes Fund line on framework to tackle capital inflows; follows criticism of framework from Indian, Brazilian officials

Janet Yellen, the vice-chair of the Federal Reserve, on Friday backed the International Monetary Fund (IMF) line on when to implement capital controls.

The IMF last month released a document, Recent Experiences in Managing Capital Inflows-Cross-Cutting Themes and Possible Policy Framework, which proposed circumstances in which the use of capital controls is appropriate.

The document advised countries to allow their exchange rate to appreciate if it is undervalued, buy foreign exchange reserves, and adjust monetary and fiscal policy before turning to capital controls.

At the Bank of Finland's conference to mark its 200th anniversary, Yellen said: "At most, capital controls should be seen as just one of many tools that can be used to manage capital inflows, and one to be used only in particularly challenging situations."

"The IMF work concludes that capital controls may be appropriate in conjunction with other policy tools as long as countries meet certain conditions. Foreign currency reserves should already be adequate, and exchange rates should not be undervalued," she added. "Controls should not be used as a substitute for necessary macroeconomic policy adjustments; for example, if the economy is overheating, controls should only be used along with a suitable monetary-fiscal policy mix. Moreover, controls should be lifted once these prerequisites no longer apply."

Yellen further called on countries to improve the resilience of their domestic financial systems in order to "reap the full benefits of financial openness".

"Setting up an adequate financial policy framework takes significant time and resources. Moreover, putting such a framework in place before liberalising capital flows is not a guarantee that countries will capture the full gains to financial openness without any attendant stresses," she said. "However, though effective regulation and supervision are not a panacea, they doubtless increase the chance that economies will benefit from financial innovation and openness."

The IMF's attempts to take the intellectual lead in developing a policy framework for controlling capital inflows have rankled with officials in two of the biggest emerging markets. At the IMF/ World Bank spring meetings, held last month, Duvvuri Subbarao, the governor of the Reserve Bank of India, said: "As regards multilateral strategies to managing capital flows, it is difficult to follow an approach that seeks to establish, standardise, prioritise or restrict the range of policy responses of the member countries that are facing large surges in volatile capital inflows."

Speaking at the same meetings, the Brazilian finance minister, Guido Mantega, was particularly scathing: "We consider some recent proposals for a possible policy framework on managing capital inflows unnecessary and lacking in evenhandedness," he said. "Brazil, for one, is doing and will continue to do whatever it thinks is necessary and adequate to its circumstances to face the challenges arising from large and volatile capital flows."

He added: "Ironically, some of the countries that are responsible for the deepest crisis since the Great Depression, and have yet to solve their own problems, are eager to prescribe codes of conduct to the rest of the world, including to countries that are overburdened by the spillover effects of the policies adopted by them."

Yellen on Friday also appeared to challenge the use of the term "macroprudential" by some emerging markets, including Brazil, to describe measures to temper the impact of capital inflows. "The IMF's work encourages countries to turn to macroprudential tools before making use of capital controls. Although admittedly no bright line differentiates these two types of policies, macroprudential tools generally are designed to enhance the resilience of the financial system, a broader and more enduring objective than directly managing capital flows," she said. "Operationally, macroprudential tools typically do not discriminate between residents and non-residents, nor differentiate by currency."

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