This introductory chapter provides an overview of capital flows to emerging markets. In principle, cross-border capital flows to emerging markets have the potential to bring several benefits; in practice, however, such flows are inherently risky—though some forms may be worse than others—potentially widening macroeconomic imbalances and creating balance-sheet vulnerabilities. As such, capital flows require active policy management, which might mean mitigating their undesirable consequences using macroeconomic and macroprudential policies, or controlling their volume and composition directly using capital account restrictions, or both. By the same token, if the inflow phase is successfully managed—through the use of structural measures to steer flows toward less risky types of liabilities, and the use of macroeconomic policies, prudential measures, and capital controls for abating the cyclical component of flows and their consequences—the economy is likely to benefit from foreign capital and to remain resilient when flows recede or reverse.
When it Rains, it Pours: Procyclical Capital Flows and Macroeconomic Policies