Policy responses to external imbalances in emerging market economies: Further empirical results

A bivariate vector-autoregression (VAR) model is used to test causal relati ons between the current account and the capital account in four emerging ma rket economies. The results show that high capital mobility could be a majo r cause of current account instability. Therefore, macroeconomic policy to restore external balance must deal directly with capital inflows. The paper recommends making nominal exchange rate sufficiently flexible to avoid inc onsistencies between short-run and long-run real exchange rates; complement ing credit tightening by fiscal restraint to reduce interest rate different ials; and strengthening reforms and surveillance of the financial system to prevent banks from excessive risk taking. [JEL C32, E61, F21, F32, F41].