unremunerated reserve requirements) are warranted, even if such restrictions have little impact on the total volume of flows. •
Should capital account restrictions be employed to affect the volume of inflows? This is only relevant if specific forms of capital account restrictions exist that can be made effective in restricting the total volume of inflows (preserving monetary autonomy).
Suppose they do.
Should they be used?
If
microeconomic distortions are weak enough to begin with, or if new prudential regulations can render them weak within a policy-relevant time frame, AND if some combination of macro instruments can be deployed to avoid the adverse consequences of overheating, the answer is no. This conclusion is consistent with the Fund’s analysis: to justify the use of capital controls to restrict the volume of inflows, some combination of micro distortions and/or macro policy inadequacies is required. •
If some level of inflows is allowed to enter the country, should the exchange rate be allowed to appreciate? If the country is committed to nominal exchange rate stability (say as in the Hong Kong currency board or in the case of Eastern European emerging economies that peg to the euro in anticipation of adopting it at some point in the future), the answer is no. But if no such rigid commitment exists, then the country faces a choice between real appreciation and expansion of aggregate demand. The more the nominal exchange rate is allowed to move, the greater the loss of competitiveness and the smaller the expansion in aggregate demand. How to decide what to do with the exchange rate in this case? The IMF’s discussion of this issue seems appropriate: the answer depends on where the real exchange rate is relative to its desired (not necessarily equilibrium) value, and on where the economy is relative to full employment. With two targets (the real exchange rate and full employment) and two instruments (the nominal exchange rate and stabilization policy, in 47